Now that the recommendations of the Sixth Pay Commission have been accepted, government employees are set to receive a good chunk of money over the next few months. It has been estimated that most government employees will effectively get a hike of around 30 per cent on the pre-tax salary that they are getting in hand. Since the hike is with effect from the start of 2006, everyone will get arrears of around 32 months. A rough estimate would be that someone who gets a pre-tax salary of Rs 40,000 a month now would get a total of around Rs 3.75 lakh as arrears.
Looked upon as savings, this is a lot of money. Someone who earns Rs 40,000 a month probably doesn't save more than three or four thousand rupees a month. At Rs 4,000 a month, it would take almost eight years to save Rs 3.75 lakh. Even if we take into account some interest income, the arrears are worth six-and-a-half years' worth of savings. For those who save less than what I've estimated, this sum could be the equivalent of what they would otherwise have saved in a decade, perhaps. Make no mistake, the size of the hike as well as the period of the arrears has made this whole thing financially very significant for many government employees.
What should be done with this money? About the worse thing I've heard is that this payout should 'boost demand in the economy', which is what some business association types have stated. What that implies is that people should go out and spend the money, presumably buying cars and LCD TVs and clothes and pizzas and whatnot and thus boost the economy. My advice to government employees is quite the opposite. Let the economy find other ways to get any boosting that it needs. These arrears are your savings you should hang on to them tightly without trying to boost anything but your own financial situation.
Remember, this money is not a windfall. A windfall (a word which sounds vaguely like it should have a rude meaning) is what Mr. Amar Singh accuses Mr. Mukesh Ambani of enjoying. An average government employee's situation is very different. The Pay Commission's award is a response not just to the rising cost of living but also to the general rise in private sector's salaries and an attempt to narrow the gap thus created. In this sense, the arrears are money that you have already spent. Given the way most people's finances are structured nowadays, I think the first priority should be to lighten or eliminate any debt load that one has. Interest paid on borrowings has risen more than that earned on deposits. A lot of us tend to have savings that earn less than the interest on the loans that we are carrying at the same time. This is especially true of credit card debt which is very expensive.
Beyond debt-reduction, the arrears money is best added to whatever savings medium you are most comfortable with. For those who want to invest for the long-term (at least five to seven years), the best course of action could be to shift this money gradually to a good balanced fund. As the last two decades have shown, despite higher volatility, equity-backed investments have long-term returns that are far superior to any other kind of asset. A type of mutual fund that get you most of the gains of equity while saving you from some of the volatility is probably the best choice.