The Union Cabinet recently approved the Terms of Reference (ToR) of the Eighth Central Pay Commission on October 28th 2025.
Much of the focus in the ToR and from the mainstream financial press has been this focus on “the need for fiscal prudence”. This of course is blind adherence to the neoliberal concept of ‘sound finance’ wherein the focus is on fiscal deficits and ‘costs’ in money terms rather than the impact it would have on the real economy. The ToR also mentions “unfunded cost of non-contributory pension schemes”, referring to the Old Pension Scheme (OPS).
There is one basic fact one must remember, “spending creates income”. You might be wondering ‘how?’. After all, for individual it appears as if income creates spending, e.g. your salary (income) allows you to consume (spend) or save.
This is true at individual level, but not true at aggregate level. Why? Because at the aggregate level, spending of one person/entity becomes the income of another. When the government, a household, or a firm spends money, it becomes income i.e. wages and profits.
When the Government increases spending by raising salaries of public sector workers, all things remaining equal, it may increase the ‘fiscal deficit’ (it’s more complicated in reality since fiscal deficit is ex-post). For the workers, the spending shows up as higher income which allows them to spend more on goods and services (consumption is a component of the GDP), businesses see greater profits and may invest (a form of spending) more (investment is another component of the GDP), generating more rounds of spending and hence income. This is called the multiplier effect.
Hence, at the aggregate level, spending precedes income. You cannot choose to earn more; you only get what others are willing to provide you but you can choose to spend more. For individuals and businesses, this happens by taking a bank loan. A bank loan creates new money which allows businesses and individuals to spend more.
Similar concept applies to the Government. Government is the sovereign issuer of its own currency. In India, the Central Government is the sovereign issuer of the Indian Rupee. This gives it special privileges. Commercial banks, like the one mentioned in the previous paragraph are authorized by the sovereign, they have accounts at the RBI which allows them to clear payments with one another at par (so, if you send ₹1,000 from SBI to ICICI Bank, you get ₹1,000 instead of a discounted amount as was the case before Central Banks existed).
Only the sovereign can create net financial assets in the non-Government sector, it does so by running fiscal deficits. When banks lend, they have to get back more money by the way of interest to earn a profit. When the Central Government spends, it becomes your financial wealth. The money in your wallet, i.e. RBI Bank Notes are the perpetual liability of the RBI. It’s in essence their debt, one they make and give you. This ‘debt’ is not comparable to private sector debt like your housing loan since that has to be paid back. This is why the Indian Government always runs a fiscal deficit, that is the non-Government surplus.
Of course, the non-Government includes everyone from foreigners, big capitalists, small capitalists, Government workers, state Governments, private workers, unemployed etc. So, individual sections among the non-Government sector may be running deficits even if in the whole the sector is in surplus. For example, if the Government gives a huge tax break to a big capitalist (you can guess who), that will increase their net financial wealth, the non-Government wealth rises even though its wealth hoarded by one individual or entity.
Hence, sectoral balances don’t tell you everything but it gives you a good idea on why Government must be in deficit and be the net spender long term. Otherwise, growth can only happen due to rise in private sector debt, which as stated previously, must be paid back. Private sector debt increases financial fragility and is unstable.
So, when the neoliberal commentators call for “fiscal prudence” in the context of Eighth Pay Commission, they are ignoring this systemic relationship. A reduction in Government spending i.e. austerity only reduces income of the non-Government sector.
Similarly, higher wages for workers who spend most of their income are not a ‘burden’, it’s an injection on purchasing power which increases aggregate demand. The question should not be ‘cost’ in money terms but real resource terms. Will this spending push the Indian economy beyond full capacity where it can’t expand. The answer is very clearly no since recent data show industrial capacity utilization is at 75% and there are mass unemployment and underemployment.
You can split the non-Government sector further into ‘Domestic non-Government sector’ and the ‘External Sector’. Exports create income for the domestic sector as its spending for the importer. Due to Trump tariffs, this income is being reduced and draining demand. To counter this, increasing domestic demand by the way of larger Government spending is crucial. The spending must increase purchasing power of the workers and replace income losses arising out of this shock. Eighth Pay Commission, if implemented without ‘pay-fors’ i.e. without cuts to spending elsewhere and without increase in taxes for those who don’t hoard (i.e. workers, mainly) will act as a counter-weight to Trump shock.
Of course, a national universal employment guarantee is also very much needed to counter the employment losses arising out of the shock. But that is not happening due to the mentality of our policymakers. Regardless, if implemented without ‘pay-fors’, the Eighth Pay Commission will be a much-needed stimulus for the economy. Unfortunately, it looks like the pay hikes will be low due to misguided ‘fiscal prudence’ and hence not sufficient to counter the shocks and low aggregate demand in general the economy is facing.