Pertinent questions on the share of informal sector in India's economy

A recently released report that says India's informal sector has shrunk, raises more questions that it answers

The debate on the predominantly informal nature of the Indian economy has had limitations with data, but it has never been boring. Three years ago, a study claimed that seven million jobs were created in 2017-18. It later turned out, as this newspaper reported first, that most of them were not new jobs, but transitions from informal jobs to formal employment. 

This November, a study by Soumya Kanti Ghosh, chief economist at the State Bank of India, India’s biggest bank, has claimed that the informal sector of India’s economy has shrunk from 52 per cent in 2018 to 20 per cent in 2021. Interestingly, Ghosh himself was the author of the first study quoted above. 

These claims raise more questions than the amount of insight they offer into the workings of the Indian economy. What are they?

Question #1: How is formal economy defined, and how does the study define formal economy/formal sector? 

Governments as well as non-governmental agencies use the definition by the International Labour Organisation (ILO) for understanding the term “informal economy”. 

In 1993, the ILO defined the informal sector with the firm or an enterprise as the basis: “A group of production units composed of unincorporated enterprises owned by households, including informal own-account enterprises and enterprises of informal employers.” 

In 2003, it added the employment aspect to it, and defined informal employment as, “All remunerative work that is not registered, regulated or protected by existing legal or regulatory frameworks, as well as non-remunerative work undertaken in an income-producing enterprise. Informal workers do not have secure employment contracts, workers' benefits, social protection or workers' representation.”

The ILO added a recommendation that essentially adds a minimum wage component to formality. 

It is worthwhile to note that employment surveys in India by the Ministry of Statistics and Programme Implementation, as well as the National Statistical Commission, have internalised these very definitions of informal sector. 

The SBI report by Ghosh, on the other hand, uses a series of indicators to prove that formalisation has increased. Apart from the “number of jobs formalised”, which rests on the expansion in the users under Employees Provident Fund Organisation, other indicators either represent increased registration of those employed informally, or a higher proportion of transactions leaving trace than before. 

For instance, it terms the new registrations under the E-SHRAM portal—a newly created database for informal workers—as “formalisation through E-SHRAM so far.” 

Then, it also likens rising digital payments to rising formalisation. This brings us to a second question.  

Question #2: Can a higher proportion of digital payments really mean a higher share of the formal economy? 

We do not have the number of the total volume of transactions in India, that includes all modes from cash to digital. But what we can do is find the ratio of digital transactions to money supply. This could be an indication of how much of the available money is transacted digitally. 

Here, we use two ways of looking at digital transactions: (a) fast payments and cards that include transactions through Unified Payments Interface (UPI), Immediate Payments Service (IMPS) and use of credit and debit cards for online transactions, point-of-sale (PoS) machines and cash withdrawal, and (b) adding NEFT or National Electronic Fund Transfer to (a). 

As reference, we narrow money for (a) and broad money for (b) as the money supply indicator. Narrow money includes currency with public and demand deposits in banks, while broad money adds time deposits (fixed or term deposits) to narrow money. 

Reserve Bank of India data shows that the rate of digital transactions to money supply in the economy has risen in the last two years.

Ratio of monthly card and fast money transactions to narrow money rose from 8.2 per cent in 2013 to 19.5 per cent in 2021. In 2021-22 to date, it has jumped to 65 per cent. If we add NEFT to digital transactions and fixed deposits in banks to money supply, the ratio of digital transactions to money supply rose from 4.7 per cent in 2012-13 to 26.7 per cent in 2021-22. 

This certainly shows that digital transactions are becoming more and more visible and transacted money in India is leaving a trace more than before. 

An RBI paper indicates that 72 per cent of transactions in India are cash-based (quoting an older report by Credit Suisse AG). It is likely that this share has reduced. 

But this is mere formalisation of transactions. This raises a third question. 

Question #3: Does this mean formalisation of work? Does this drastically reduce the number of informal workers in India?

In 2017-18, 52 per cent of India’s economy (informal) supported 90.7 per cent of India’s workers (informal). This data is from a paper by S V Ramana Murthy, former additional director general with the MoSPI and member of the National Statistical Commission. 

In 2019-20, the Periodic Labour Force Survey puts the number of informal workers—including farm workers—at 376 million. 

If in 2021, the share of the informal economy has dropped to 20 per cent, has the share of informal workers also dropped to—say—50 per cent, or still lower? 

Until the PLFS for 2021-22 comes in—which might happen somewhere in 2023-24—we would not be able to get a precise number of informal workers, or their share, in India’s workforce. 

But before that, the government may get an estimate of the size of the informal workforce from the E-SHRAM portal, which is a database-in-making for the same. 

To date (as of November 17, 2021, 1 pm), 80 million informal workers have registered on the portal. Out of 376 million, this translates into 21 per cent of informal workers being in the system. 

But does this guarantee them any social security, like a provident fund, or any kind of retirement benefits? Does it make them formal?