India's economy takes 'formal' leap as informal shrinks drastically: Study

15-20% of economy informal now as against 52% in FY18; digitisation, gig economy key drivers: Study

The share of the informal sector in India’s economy fell drastically to 15-20 per cent in 2020-21 from 52.4 per cent in 2017-18 due to digitisation and the rapidly expanding gig economy, according to a study by SBI Research.

“Currently, the informal economy is possibly at maximum 15-20 per cent of gross value added (GVA)," said Soumya Kanti Ghosh, group chief economic advisor, SBI.

The share stood at 53.9 per cent in 2011-12. As such, the formalisation of the economy crawled between 2011-12 and 2017-18 but gathered pace between 2017-18 and 2020-21.

However, Madan Sabnavis, chief economist at CARE Ratings, said the employment approach to formalisation had yielded these results, but if the structure of the economy in terms of output was taken into account, 40-45 per cent was still informal.  

Aditi Nayar, chief economist at ICRA, did not comment on the study, but said the large and formal players were gaining at the cost of the smaller and less-formal entities in various sectors. This is evidenced by the sharp disparity in the performance of the stock markets, robust growth in direct tax collection, and improved business sentiment, juxtaposed with the continued pessimism displayed by urban households in the Reserve Bank of India’s latest consumer confidence survey, she said. The latter is a likely reflection of the lingering income uncertainty being faced by households that are dependent on the less formal and contact-intensive sectors of the economy, she added.

India's GVA declined 3 per cent in terms of current prices, but the largest informal sector -- agriculture and allied -- grew 6.6 per cent in FY21. Also, over 20 million households availed of work under the Mahatma Gandhi National Rural Employment Guarantee Scheme for 10 months each till September this year.

The study by SBI Research attributed the rapid pace of formalisation to a plethora of measures taken since 2016 that accelerated the digitalisation of the economy and the emergence of the gig economy. The formalisation in India post-2016 happened at a rate "possibly" faster than most other nations, it said.

The study referred to the International Monetary Fund (IMF) observation that formalisation had increased in India since the adoption of goods and services tax (GST), enhanced digitalisation, and demonetisation.

It advised the government that even as the economy gets formalised, it is important and ethical to have a better designed tax structure, particularly indirect taxes on items like fuel, to support honest tax-paying households.

With certain assumptions, the study estimated that 114 million tax-paying households, or 8.5 per cent of the population, contributed Rs 75 trillion, or 65 per cent, to the private final consumption expenditure and cross-subsidised 91.5 per cent of the population during FY21.

"To that extent, the existing tax structure, particularly of indirect taxes on fuel, should not be consumption negative," said Ghosh.

The informal sector in India consists of enterprises that are own account enterprises and operated by own account workers or unorganised enterprises employing hired workers. They are essentially proprietary and partnership enterprises.

The share of the unorganised sector was the highest in agriculture as holdings are small and fragmented. Since FY18, the agriculture sector has been formalised by 22-27 percentage points due to the increasing penetration of kisan credit cards. In agriculture, the informal share is now in the range of 70-75 per cent as against 97.1 per cent during FY18 and 96.8 per cent in FY12, SBI Research said. The study estimated that kisan credit cards have formalised Rs 4.6 trillion.

In all the segments of the economy, the share of the informal sector has declined. In fact, it did not have any share in electricity, gas and water during FY21.

The study's starting point was the assumption that the shrinkage in the economy after the onset of the pandemic was mostly informal, and hence, the loss in the output across sectors gave us the measure of the informal sector. This assumption ensured that the size of the informal economy is still overstated as the shrinkage in economy also consisted of formal.

"This ensures that our estimate is at least free from any downward bias in measurement," Ghosh said.

The significant formalisation efforts of the government have resulted in almost 100 per cent formalisation in finance and insurance, and to a large extent in real estate and agriculture, the study said.

The informal size of the trade, hotels, transport, communication & broadcasting sectors, which employ around 170 million households according to the 2011 census, was at 40 per cent during FY21. The informal sector in construction was at around 34 per cent.

The study said that with the rise in economic activities, the consumption of petrol and diesel is estimated to increase by 7,215 million litres in FY22. By assuming 50 per cent of additional petrol and 25 per cent of diesel is paid by digital modes at petrol stations, approximately Rs 23,686 crore has been formalised at petrol pumps. "So, in the last 5 years, around Rs 1 trillion has been formalised," it said.

The report said one of the sources to analyse the extent of formalisation is the monthly Employees' Provident Fund (EPF) payroll report, which provides data on establishments remitting first ECR (electronic challan-cum-return) in a particular month. Based on this data, it estimated that almost 3.7 million jobs have been formalised till August this year.

The study also estimated that till date the rate of formalisation due to e-shram portals is around 17 per cent and will increase further. The e-shram portal, launched on August 26, is a central database of unorganised workers to make them employable and extend the benefits of social security schemes to them. As many as 57 million unorganised workers registered themselves on the portal till October 30, with 62 per cent of workers belonging to the age-group of 18-40 years and 92 per cent registered workers having monthly income of less than Rs 10,000.

Madan Sabnavis, chief economist at CARE Ratings, said the employment approach to formalisation of the economy has yielded these results, but if structure of the economy in terms of output is taken into account, 40-45 per cent of the economy is still informal.  

Aditi Nayar, chief economist at ICRA, did not comment on the study. However, she said the large and formal players are gaining at the cost of the smaller and less-formal entities in various sectors. This is evidenced by the sharp disparity in the performance of the stock markets, robust growth in direct tax collections and improved business sentiment, juxtaposed with the continued pessimism displayed by urban households in the RBI’s latest consumer confidence survey. The latter is a likely reflection of the lingering income uncertainty being faced by households that are dependent on the less formal and contact-intensive portions of the economy.

India's GVA declined three per cent at current prices, but the largest informal sector --agriculture and allied -- grew 6.6 per cent in 2020-21. Also, over 20 million households have been availing work under the Mahatma Gandhi National Rural Employment Guarantee Scheme for ten months each till September this year.