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The Union Cabinet in India approved the setting up of the 8th Central Pay Commission (CPC) on 16 January 2025. The Commission is vested with the responsibility to update the government employees’ pay scales—affecting their salaries, pensions, and allowances—considering the prevailing economic conditions, inflation, and the changing demands of public servants. In the process, the Commission will recommend principles governing the pay structure of several employee categories, primarily focusing on Central Government employees. The implementation of the recommendations is scheduled for 1 January 2026.
The Commission will recommend principles governing the pay structure of several employee categories, primarily focusing on Central Government employees.
As of 2019-20, of the 58.9 million formal workers, 3.06 million are employed by the Central Government. Any revisions made to the pay structure of government employees will have concomitant effects on private sector wages due to market forces, resulting in an economy-wide wage revision. This will have implications for domestic consumption, which, being the growth driver, will directly affect the Gross Domestic Product (GDP) and national welfare. Thus, the commission’s potential impact on wages, living standards, and its budgetary consequences deserve scrutiny. All this begins with the Indian growth story that has largely been driven by consumption over the last three decades.
Consumption-led growth
India’s consumption-led growth story since the market-oriented reforms of 1991 can be discerned from the fact that alongside private consumption expenditure, constituting around 55-60 percent of the GDP (which served as the largest component of domestic expenditure), GDP growth showed a co-movement(see Figure 1). One needs to note here that the marginal propensity to consume (or the increase in consumption with a unit rise in income) is higher for lower-income groups as compared to higher-income groups. The consumption multiplier (i.e. the aggregate increase in GDP due to a unit increase in consumption) is directly proportional to the propensity to consume. India’s income level, particularly its lower per capita income, provides it the advantage of a high consumption multiplier. This follows from the intuition that, with higher income levels, the marginal propensity to consume (out of additional income) declines, implying that households consume more at lower levels of incomes and tend to save more with higher earnings. Thus, increases in incomes through wages and salaries or otherwise at lower income levels will boost consumption expenditure and drive GDP growth.
Source: MOSPI
While China is attempting to attain a domestic consumption-driven growth trajectory through deliberate policy interventions, India has an organic advantage, underpinned by its income level and demographic structure. The CPC can act as a stimulus to this trajectory by hiking salaries and pensions for government employees. The commission can therefore inject purchasing power into the economy, fostering demand for goods and services. With the 8th Pay Commission’s inflation-indexed salary corrections, the cycle of increasing purchasing power and consumption could gain further momentum, reinforcing economic growth.
The CPC can act as a stimulus to this trajectory by hiking salaries and pensions for government employees.
The wage effect: Competitiveness, social security and productivity
So far, the important role played by pay commissions is to bridge the wage gap between public and private sector employees. Government jobs in India, traditionally valued for their security and superannuation schemes, become even more attractive with successive pay hikes. Through market forces, this dynamic exerts upward pressure on private-sector wages as well. Greater wages and higher security draw skilled employees toward the public sector—forcing private firms to attract talent by offering competitive or, to be precise, marked-up remuneration. This is because, while the compensation during working life might be higher in the private sector as compared to the governmental or public sector jobs, the retirement benefits in the latter have earlier been much more lucrative (especially those covered in the Old Pension Scheme in India).
With pay commissions successively changing pay structures and dearness allowances, in many cases, retired individuals from governmental jobs draw pensions under the Old Pension Scheme that exceed their last-drawn salaries. This has created a unique dual-driver of consumption, with both the working youth and pensioners contributing to consumption demand. Even though the marginal propensity to consume tends to be lower among the aged (or retired), there is a second factor that comes into play here. Greater savings by high-income households and pensioners enhance the national savings rate, which leads to greater investment and capital accumulation. This is something that the 8th CPC is also expected to boost.
An organic shift towards greater investment can bode well for manufacturing, leading to greater exports and employment.
According to neoclassical theory, where savings lead to capital formation, a higher savings rate can bolster growth by initiating a shift towards an investment-led growth path. An organic shift towards greater investment can bode well for manufacturing, leading to greater exports and employment. With strategic foresight, these funds can be channelled into infrastructure, technology, and other priority sectors, bridging the gap between consumption-driven growth and investment-led expansion. Moreover, a greater influx of savings in the funds market will lower interest rates and ease the interest burden of the government. It can then finance expenditures at lower costs, thereby meeting its fiscal deficit targets.
Implications for the Budget and inflation
While the economic benefits of pay revisions are evident, they come with significant budgetary consequences. The central government spends around 7.29 percent of its revenue expenditure on the pay and allowances of civilian employees. Thus, revised pay structures can put upward pressure on the fiscal deficit, especially when the government has been targeting a lower revenue deficit. Higher salaries and pensions will increase government expenditure, strain fiscal resources and lead to a greater deficit. However, these outlays should be viewed as investments in human capital and economic growth.
Though there is no denying that the multiplier effect of revenue expenditure is way lower than capital expenditure, there are two forces that will help compensate for the opportunity cost of putting money into revenue expenditure. The first is the consumption-boosting factor associated with salary or pension income increases that will spur growth through the consumption multiplier effect. The second is the potential increase in savings and the lowering of interest rates that will simultaneously reduce the borrowing cost for the government, and result in lower revenue expenditure. This will provide the government with more wiggle room to boost capital expenditure and gear up production. Over the long run, lower fiscal deficits will also indicate stable domestic conditions and attract foreign investments, further lowering the cost of borrowing for businesses. Thus, an initial blow to the revenue deficit can facilitate long-run dynamics that will boost productivity, spur growth and ease government budgetary constraints.
Over the long run, lower fiscal deficits will also indicate stable domestic conditions and attract foreign investments, further lowering the cost of borrowing for businesses.
Another challenge lies in mitigating risks such as demand-pull inflation, where heightened consumption will drive up prices. This can be countered by addressing supply-side bottlenecks, ensuring that increased demand does not outpace the economy's capacity to supply goods and services. In other words, as long as economic growth outpaces inflation, individuals with inflation-indexed wages will be better off. That said, this comes with a caveat—the investment created due to higher savings has to be directed towards productive activities. Moreover, activities with shorter gestation periods and greater social return have to be prioritised.
A step closer to Viksit Bharat
As India integrates itself into the global economy, aligning wages with international standards based on purchasing power parity (PPP) is essential. A competitive salary structure will not only attract and retain top domestic talent but also position India as a preferred destination for global professionals. It will also enable worker repatriation, resulting in productivity and knowledge gains in the long run. With the correct measures to enforce PPP-indexed salary structures, the th CPC could enhance India’s human capital base, driving innovation and productivity across sectors.
The 8th Pay Commission represents an opportunity to recalibrate India’s economic framework for the future through direct impacts on employment and consumption. By balancing consumption growth, social security, and fiscal prudence, it can promote sustainable development. As India aspires to reach high-income per capita levels by 2047, globally competitive wages and robust public sector standards will play a decisive role in attracting talent, driving growth, and achieving its vision of a prosperous and inclusive nation.
Nilanjan Ghosh leads the Centre for New Economic Diplomacy (CNED) and the Kolkata Centre at the Observer Research Foundation.
Arya Roy Bardhan is a Research Assistant with the Centre for New Economic Diplomacy at the Observer Research Foundation.
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