A proposed increase in government salaries could threaten New Delhi's fiscal deficit target and limit overall capital spending, overshadowing potential gains to consumption.
In India, a government-appointed panel known as the Pay Commission meets every 10 years or so to revise the salaries of central government employees. This year, the Seventh Commission recommended Asia's third-largest economy adopt a 23.5 percent increase in wages and pensions for the 2016-2017 financial year.
The financial impact of implementing these measures is estimated at 1 trillion rupees ($15 billion), the bulk of which will be absorbed by the next federal budget, according to the panel.
But that spells trouble for the government's 2016-2017 fiscal target, which is 3.5 percent of gross domestic product (GDP), compared to 3.9 for the current year.
If the wage increases are implemented, Morgan Stanley expects the 2016-2017 deficit to widen to 3.9 percent.
"With the Pay Commission recommendations to be likely taken up, the trend of fiscal consolidation is likely to be delayed - we expect the central government to see slippage in the deficit vs. target levels," the bank said in a Friday report.