7th Pay Commission: HRA allowances of central government employees key concern for RBI, monetary policy ahead

Since the time 7th Pay Commission has been approved by Union Cabinet, the indicator, which is supposed to bring good days to many central government employees has been giving sleepless nights to the Reserve Bank of India, especially while deciding on CPI inflation! All eyes are currently watching RBI, which will be announcing India’s fourth bi-monthly monetary policy for fiscal year FY19. RBI has been very firm on how 7th Pay Commission continues to put pressure on inflation. 

In August 2018 policy, RBI, while increasing policy repo rate by another 25 basis points to 6.50% from previous 6.25%, listed factors that can hamper CPI trajectory going ahead. Among these was also 7th Pay Commission HRA allowance . 

RBI said, "Retail inflation, measured by the year-on-year change in the CPI, rose from 4.9 per cent in May to 5 per cent in June, driven by an uptick in inflation in fuel and in items other than food and fuel even as food inflation remained muted due to lower than usual seasonal uptick in prices of fruits and vegetables in summer months. Adjusting for the estimated impact of the 7th central pay commission’s house rent allowances (HRA), headline inflation increased from 4.5 per cent in May to 4.6 per cent in June. Low inflation continued in cereals, meat, milk, oil, spices and non-alcoholic beverages, and pulses and sugar prices remained in deflation."

Providing an inflation outlook, RBI said, "The inflation outlook is likely to be shaped by several factors." Few of the important indicators were MSP, government’s procurement operations, monsoon, crude oil prices, government reduction in Goods and Services Tax (GST) rates on several goods and services, inflation in items excluding food and fuel and volatility in financial markets. 

Based on an assessment of the above-mentioned factors, RBI projected inflation at 4.6 per cent in Q2, 4.8 per cent in H2 of 2018-19 and 5.0 per cent in Q1:2019-20, with risks evenly balanced."

Interestingly, RBI believes if HRA impact impact was excluded then, CPI inflation is projected at 4.4 per cent in Q2, 4.7-4.8 per cent in H2 and 5.0 per cent in Q1:2019-20. 

RBI explained that, the staggered impact of HRA revision by state governments may push headline inflation up. While the statistical impact of HRA revisions will be looked through, there is need to watch out for any second-round impact on inflation.

Recently, the CPI or retail inflation eased to 3.69% during the month of August 2018 lower compared to 4.17% of the previous month. In the past two months, headline inflation has fallen 120bp. Adjusted core inflation (ex-HRA and commodities) slowed to 5%, down about 50bps over the past two months, suggesting that the rising trend over the past six–eight months is now reversing. 

However, core inflation has remain one key indicator that impacts CPI's growth trajectory ahead. Though excluding commodities and HRA, the core inflation has eased in August numbers, it still does not mean the pressure is over.

Explaining about core inflation, Motilal Oswal gave in details about  all nine components in the core CPI – housing (10.1%), clothing & footwear (6.5%), transport & communication excluding fuel items (6.2%), health (5.9%), education (4.5%), personal care & effects (3.9%), household goods & services (3.8%), fuel items (2.4%) and recreation & amusement (1.7%). 

It was known that,  fuel items alone contributed about half the rise in core inflation over the past six months. While, housing – driven primarily by the statistical effect of housing rent allowance (HRA) – accounted for almost one third of the total rise over the past one year. Lastly, health & education has contributed one fourth of the rise in core inflation over the past one year and as much as one third over the past six months. 

Considering this, Motilal said, "Overall, these four items have together accounted for about two thirds of the rise in core inflation over the past six months and also over the past one year. Interestingly, neither ‘fuel’ nor ‘housing’ components reflect over-heating in the domestic economic environment."