Introduction: A Fiscal and Policy Turning Point
The Cabinet’s approval of the Terms of Reference for the 8th Central Pay Commission (CPC), covering nearly 50 lakh central government employees and about 69 lakh pensioners, marks the onset of a process that will inevitably increase the Centre’s medium-term recurring expenditure on pay and pensions in line with current realities and maintain parity with similar roles in the private sector and public enterprises.
The Commission must report in 18 months and may consider, “if necessary, sending interim reports on any of the matters as and when the recommendations are finalized”, the finance ministry’s statement said. This high-leverage policy move may also entail significant one-time arrears if retrospective implementation is recommended.
The Union Budget for FY2025–26 currently projects a fiscal deficit of 4.4% of GDP and a revenue deficit of 1.5% and has already sizable recurring outlays (interest payments and subsidies). Any large new recurring obligation will either push the deficit up or force offsetting cuts. Recent monthly accounts show cumulative expenditure and large interest/subsidy burdens already in the system.
Fiscal Architecture- Channels of Impact
The main channels of fiscal impact are:
. Higher recurring revenue expenditure (salaries + pensions + allowances). Pay-commission recommendations, once accepted, become permanent increases in the wage bill and pension outlays — i.e., they are structural, not one-off. The central government bears most of this directly (with some burden on railways, PSUs, and states depending on design).
· Arrears on retrospective recommendations. Historically, arrears have been a substantial one-time cash outflow (7th CPC arrears were a major short-term demand boost). Arrears add to near-term fiscal pressure even if the recurrent annual cost is the headline number.
· Crowding and trade-offs. With constrained fiscal room, higher wage/pension bills either raise the deficit (and hence borrowings) or force reprioritisation (lower capital spending, lower subsidies, or tax increases). There are issues of “crowding-out” of private investment by fiscal deficits; “crowding-out” of government capital expenditure by growing interest payments; and “crowding-in” of private investment by public investment. These interdependent issues in the overarching context of a fiscal deficit overhang require a multi-layered examination to address the peculiar debt and deficit profile and fiscal risk across States for sustainable fiscal recovery and containing the fiscal deficit within manageable proportions. In the ultimate analysis, fiscal policy and monetary policy must move in tandem. For, growth and fiscal deficit are not contradictory but complementary. The government’s choice determines medium-term growth vs. fiscal consolidation trade-offs.
Budget-cycle mechanics-Burgeoning Fiscal Deficit
Public finance metric is a persisting weakness in India’s credit profile; its fiscal deficit, interest-to-revenue and debt ratios are still relatively high. Over the last ten years, the NDA Government has successfully straddled a knife-edge equilibrium between the requirements of economic growth and the need to promote the welfare of disadvantaged sections. But the NDA Government has largely been fiscally prudent (the once-in-a-century Covid-19 event necessitated countercyclical fiscal measures and a more active fiscal policy for macroeconomic stabilisation; fiscal stimulus differed across countries because of the size of automatic stabilisers, fiscal multipliers, and fiscal space).
The calamitous effects of large deficits and growing debt were succinctly brought out by Martin Feldstein, “Fiscal deficits are like obesity. You can see your weight rising on the scale and notice that your clothing size is increasing, but there is no sense of urgency in dealing with the problem. That is so even though the long-term consequences of being overweight include an increased risk of a sudden heart attack as well as of various chronic conditions like diabetes… I emphasize the analogy to stress the point that budget deficits need attention now, even when their adverse effects may not be obvious”.
While the exact fiscal impact remains uncertain, the 7th CPC (2016) serves as a useful reference point: it added roughly ₹1.02 lakh crore, including pay, allowances, and pensions. The 2026 Budget (to be presented in February 2026) will have to incorporate either the projected recurring cost or explicit provision for arrears and new pay/pension lines, making the next Budget cycle politically and technically constrained.
The incremental recurring expenses and arrears added ~0.4–0.65% of GDP to the fiscal deficit in the immediate year, thereby substantially constraining fiscal flexibility at the time, and could do so again. The earlier studies of Pay Commissions suggest implementation can raise the government’s GFD/GDP ratio by 0.4–1.0 percentage points. This would, however, depend on the scale (size of hikes, fitment factor, arrears, who bears the cost). These data ranges could usefully serve as scenario anchors.
An extrapolation of this data to the present situation reveals that the recurring annual cost would likely be ₹0.6–1.5 lakh crore, depending on the structure, while arrears could add another large one-time bill, the precise numbers being a function of fitment and DA adjustments. The new pay and pension structure will likely be effective from January 1, 2026, maintaining the 10-year cycle between commissions.
Where Do We Go from Here? Key Developments and Insights
“Stick to the big questions, don’t get bogged down in the details.” Heather Ferguson
The subsequent Budget (February 2026) will need to outline how the government plans to accommodate these additional costs, whether through expenditure offsets, phased implementation (spread additional pay increases across years), enhanced revenues (e.g., new or broadened taxes, improved GST collections) to retain deficit targets, increased borrowing, reprioritisation of capital vs revenue spending exacerbating the pressure on capex if revenue spending rises. These factors risk growth outcomes should capex reduce, and the use of one-off resources (e.g., divestment receipts, asset monetisation) to cover arrears without a recurring fiscal hit.
There could also be higher risks and second-order effects manifested in higher debt or increased interest payments over time, leading to further crowding out; keeping up with the Joneses, i.e., greater pressure on State governments and PSUs to follow suit, transmitting fiscal pressure to states too (joint fiscal space shock); wage–price dynamics in case of sustained inflation; and the political economy of hikes inducing generous front-loading.
CPI Precedent Data-Inflationary Spiral
Each option carries distinct implications for growth and inflation, with the potential for modest to perceptible upward pressure on consumer prices. The case for a fresh revision stemmed from inflation, cost of living, and service conditions evolving over the past few years. But pay revisions raise inflationary pressure during the period of transition through three channels:
1. Direct channel: more disposable income for 50 lakh employees + 69 lakh pensioners leads to higher consumption, particularly goods and services where these households spend (urban consumption, services, retail, housing).
2. Indirect channel: anticipatory spending (buy now), and multiplier effects via consumption supply chains.
3. Fiscal channel: if the government finances the increase by higher borrowing, that can be neutral for CPI in the short run, but it raises demand via bank liquidity. It can put upward pressure on interest rates and asset prices.
Pathway to the Future – “Nam et ipsa scientia potestas est.” (For also knowledge itself is power.) Francis Bacon. Mediationes Sacrae “Of Heresies” (1597).
Historical evidence and a definitive macro logic suggest a modest but visible upward CPI inflationary pressure in the 0.1–0.6 percentage-point range. The exact outcome, however, depends on whether increases are phased vs. frontloaded (arrears cause a bigger short-run effect), spare capacity in the economy (if supply is tight, the same spending pushes prices more), commodity/food supply conditions, and the monetary policy response to any demand shock.
Given these uncertainties, close monitoring of policy levers will be required. A well-defined growth and structural strategy must factor in official cost estimates, the implementation timeline, and retrospective effect. There are also considerations of Budget documents, and revised estimates for FY2025–26 to see whether borrowings or reprioritisations are adjusted, monthly fiscal accounts, and RBI commentary and bond market reactions reflecting market pricing of inflation and fiscal risk impacting a holistic assessment and perspective.
ABOUT THE AUTHOR
Dr. Manoranjan Sharma is Chief Economist, Infomerics, India. With a brilliant academic record, he has over 250 publications and six books. His views have been cited in the Associated Press, New York; Dow Jones, New York; International Herald Tribune, New York; Wall Street Journal, New York.
