This Article is From Apr 27, 2020

Why Government's DA Decision Will Hurt, Not Help, Economy

Everyone knows that job security for government workers is high, but they get paid less than the private sector and annual increments are meagre. Where private sector executives get their pay packets completely reset every few years (assuming their employers are not in losses), government employees have to wait for a decade for Pay Commissions to rework their salaries. In between those reboots, twice a year, the government revises their Dearness Allowance or DA, which is intended at offsetting the impact of inflation. DA hikes are even more crucial for retired government employees who live off their pensions.

So one can imagine the disappointment government employees must have felt when, last week, the Modi sarkaar decided to freeze this year's DA increase. What was expected to come through in January will now be given only next June. And there'll be no arrears paid either. This will affect about 48 lakh current employees and another 65 lakh pensioners. State governments are likely to follow suit for their own employees. Once they freeze DA hikes, estimates suggest, there'll be a total saving of about Rs.1.2 lakh crore this year. 

But this is not just about government staff being disappointed - the DA decision will have a massive negative impact on the economy as a whole. That's because government employees make up a significant portion of India's middle class, which is the only section of the country's population which can spend beyond basic necessities. There is no clear data on the size of India's middle class, so I will use income tax data and rural income surveys to get ballpark numbers.

Income tax data for the year 2017-18 tells us that 75 percent of those who filed returns had an average monthly income of about Rs 25,000 - Rs 60,000 per month. The government's 2016 employment survey tells us that on average, there are about 1.3 earning members in families which depend on monthly salaries. I will use that as a proxy to work out the average monthly household income of tax-paying families. That tells us that 75 percent of families filing returns earned between Rs 30,000 - Rs 75,000 in 2017-18. In 2019-20 prices, that range translates to about Rs 35,000 to Rs 80,000 per month. We can safely say that these people belong to the 'middle class'.

There were about 5.5 crore individuals who filed IT returns for 2017-18. Again, using the same 1.3 earning member per family - now as a divisor - we can assume that there were about 4.2 crore families in India which filed tax returns. Of this, less than 3.2 crore were 'middle class' families, which was less than 12 percent of all Indian households in 2018. Today, that number will be about 3.25 crore households.

Add to this, the rural middle class. In this case, the earnings cut-off will be slightly lower - let's say Rs 25,000 in today's prices. We can use the 2017 Rural Financial Inclusion Survey to get a sense of the numbers here. It says that the top 10 percent of rural households had a monthly income of between Rs 23,375 - Rs 48,833. In today's prices that's about Rs 26,000 to Rs 55,000. In other words, less than 2 crore rural families today can be assumed to be part of the 'buying' classes. Add the tax paying 3.25 crore middle class, and the 40 lakh families who earn more Rs 1,00,000 a month, and we get about 5.6 crore out of a total of 28 crore households in India who sustain most of our consumption demand. That is just 20 percent of all Indian families.

Coming back to the government sector, a 2016 estimate suggested that India had 1,622 government employees per 100,000 people. If one assumes the ratio has remained more or less the same, then there are currently about 2.2 crore people employed by the centre and state governments. Using the same 1.3 divisor that we used earlier, we get a number of about 1.7 crore households who are dependent on government employment.

How many of these will fall within the 'middle class' bracket? Data shared in the Lok Sabha in November last year shows that the average gross salary (including bonuses and allowances) of a central government employee was about Rs 51,000 in March 2018. In today's prices, that's about Rs 55,000 per month. Since the government pays more than the market at the bottom of the scale, and much less than market rate to top officials, one can safely assume that at least half of all government employees will fall within our 'middle class' income range. We said that approximately 1.7 crore households depend on central and state government jobs - half of that is about 0.85 crore households. In other words, out of the total 5.6 crore 'middle class' households in India, about 15 percent depend on government salaries.

We already know that the remaining 85 percent, who either have private sector bosses or are self-employed, are facing a terrible time during the lockdown. Most businesses - small, medium or large - have virtually no cash flow right now and they've been forced to downsize, impose pay cuts or send employees on unpaid leave. This will have a big impact on middle class consumption even after the lockdown ends. Developed countries have ring-fenced this demand by offering unending credit lines and wage-aid to companies. Denmark will cover 75 percent of wages if businesses continue to employ people. Germany has announced a special 26-billion Euro fund to finance 60 percent of wages. The Austrian government is guaranteeing between 80-90 percent of wages, depending on the salary level of a worker. Ireland is paying 85 percent of take-home pay of workers up to 412 Euro a week (Rs 34,000 a week). The list of governments helping corporates pay their workers is endless.

The Modi government, on the other hand, hasn't done anything to help companies continue paying salaries to their employees. Instead, the PM has appealed to corporates to not sack people or cut their wages. Of course, the government doesn't have to follow its own advice when it comes to paying its employees the promised DA. On top of it, by freezing DA hikes, the Modi government is actually making recovery even more difficult.

By not paying the extra DA, the centre and states will save an estimated Rs.1.2 lakh crore, which would have otherwise gone into the hands of government employees who would have spent a big part of it. If we assume that two-thirds of this money was to be spent on consumption, the government has effectively taken away about Rs 80,000 crore of consumption expenditure from the middle class. If that money is given to the poor, it will be spent on bare necessities, which will have little effect on the goods and services that businesses produce.

In fact, it is not just about direct middle class consumption. An RBI study from 2002 suggests that every Rs 2 spent in private consumption generates an income of Rs 5 in the economy as a whole. In other words, the Rs 80,000 core of additional consumption that is being denied to government employees this year could have generated nearly Rs 2 lakh crore - or about one percent of GDP - in additional national income. This would have been a crucial source of demand to help the private sector recover after the lockdown ends.

Manmohan Singh knew this when he was PM and had to steer the Indian economy after the global financial crisis of 2008-09. The sixth Pay Commission had just submitted its recommendations. The UPA government could have chosen austerity and postponed its implementation. At the very least, the government could have frozen the Rs 18,000 crore arrears that had to be paid with effect from New Year's Day, 2006. Instead, it implemented it quickly and pumped in about Rs 26,000 crore in additional demand. This helped India keep its nose above water in 2008-09, growing at 3.1 percent and then 8 percent plus GDP growth over the next two years.

The Modi government is doing the right thing by spending on the poor and ensuring they get subsidised food. But it could have easily done that by expanding its fiscal deficit, like every other government is doing. Right now, it is simply robbing Peter to pay Paul, and the overall impact on the economy will be bad for both. 

(Aunindyo Chakravarty was Senior Managing Editor of NDTV's Hindi and Business news channels.)

Disclaimer: The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of NDTV and NDTV does not assume any responsibility or liability for the same.