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Wednesday, December 6, 2023

Formalisation is imperative for growth

The informal sector accounts for about 1/3rd GDP of low and middle income economies with an astonishing 70% of all employment while accounts for 15% of GDP in advanced economies with 16% of all employment, says World Bank.

International Labour Organisation (ILO) states that about more than 60 per cent of the world’s employed population are in the informal economy.

Informality as a share in GDP was seen at large in Sub-Saharan Africa, Latin America and Caribbean region during 2010-17 at 34% of GDP compared with just 9% of GDP for North America, according to an IMF blog. Sub-Saharan Africa (62%) and South Asia (59%) have the highest levels of informality, while Europe and East Asia are the regions with least levels of informality. Bharat’s estimate done as of FY2018 suggests the size of informal economy at 52% of GDP.

The size of the informal economy as a percentage of global growth had fallen gradually across the countries in pre-Covid era however Covid-19 has pushed many people out of formal employment and into informality. This has proven devastating for informal workers who are largely excluded from formal social safety nets, have low incomes, and limited savings or access to government support programs.

The degree of informality in a country varies according to its characteristics. The informal sector is more pervasive in emerging and developing nations than the developed nations because as the countries develop, it becomes easier for the informal/unorganised workers to transition to formal economy. They can find jobs easily and supplement their income in the regulated formal sector with improved access to finance and services. The rationale is extended from mere survival of workforce to a viable workforce that adds up to maximising resources of the country.

There is no one-solution fit for all in bringing down the informal economy however the growing number of countries worldwide are reducing the cost of doing business, reducing their registration and compliance burdens, and are focussing on financial inclusion with digitisation and other social benefits to push formalisation in their economies.

Improving access to and quality of education is probably the single most powerful way to lower informality. Designing tax system to avoid inadvertently increasing incentives for individuals and firms to remain in the informal sector, building reforms or revamping policies to enhance financial inclusion by promoting expanded access to formal financial services can help lower informality. And a range of structural policies can help increase incentives and lower the cost of formalization.

What drives informality in Bharat?

We usually interpret informal worker as someone who is not registered with companies, have no formal employment contracts, no social benefits or someone who is out of the tax net in spite of having registered with companies or someone who is outside the formal financial system.

There is no clear definition for informal economy. Informality is measured according to some estimates taken through surveys or indirect indicators. This is often also known as shadow economy that runs on a small scale with no official statistics on it. So there could be numerous drivers –

  • Huge labour workforce – Large number of workforce is employed in rural due to agriculture but also a large chunk prevails in urban informal sector. The migrant labourers such as street vendors, traders, brokers, commission agents and small businesses who work for manufacturing, construction and retail sectors do not come under tax net and cannot avail any formal social benefits like pension, gratuity and salaries.
  • Vulnerability – They are exposed to exogenous shocks such as pandemic since they don’t have fixed income and no regular working hours yet lower earnings. The pandemic had shaken all contact intensive sectors where we see domestic workers, market vendors and taxi drivers prevailing.
  • Lagging Economies of Scale – MSME’s and household businesses run on small scale and hence cannot take advantage of reducing costs by increased level of production like big firms and hence cannot compete and remain small forever.
  • Unregulated – Small scale businesses are not directly regulated so the small businessmen avoid taxes by hiding incomes and expenses due to cumbersome regulatory burden and hence remain out of formal tax structure.
  • No Monitoring – The businesses are not monitored as there is no official statistics to measure the size of informal economy since the household businesses are of miniscule size and remain unnoticeable.
  • Non-essential produce – The products that are produced by such informal small enterprises are non-essential items whose demand was diminished during the time of pandemic. This way rural families had lost their marginal incomes and slipped to below poverty line simply surviving on their savings.

Some informal employees are self-employed and others rely on informal activities as a safety net since they don’t have any choice. They lack education and skills to find employment and do not gain enough access to formal lending and borrowing from banks and other institutions.

Since the informal sector does not contribute to taxes, the government will not be able to increase its resources to maximum levels that it can use to bridge the fiscal gap. Informal sector slows down the output of the country hence the condition of labour force is attributed to the growth in the country.

Formalisation instrumental in self-reliance

The informal workers need job security, wage security and social security and if Bharat can provide all of this, then it will become easy for unorganised workers to increase their contribution as well as align with the self-reliance initiatives across the sectors.

GST was one nation one tax reform brought in to reduce tax evasion. India has kept lower GST threshold compared to other countries to reduce burden for small businesses and the provision discourage the registered business to deal with unregistered entities in the informal sector. Correspondingly, the informal sector entity is encouraged to get itself registered, i.e. to join the formal sector to remain in the supply chain even though it may not be under any obligation to register because of its turnover being below the threshold of Rs 20 lakh per annum.

According to SBI’s recent October’21 report, Bharat has a large informal economy with around 93% of its total workforce earning their livelihoods as informal workers (NSSO 2014). The report says that Bharat’s informal economy has shrunk from 52% of GDP in FY18 to 15-20% of GDP in FY21 owing to the several efforts being taken by the government towards formalisation.

Several efforts such as Atmanirbhar Bharat Abhiyan, new labour reforms for the gig economy, E-Shram portal, Udyam portal, PM-Shram Yogi Maan-Dhan, PM SVANidhi, One nation One Ration card, MGNREGA, Deendayal Antyodaya Yojana National Urban Livelihoods Mission, have been taken in the direction of moving towards formal economy.

Source: SBI report prepared based on employment and digitalisation parameters

Government Initiatives

There have been sincere efforts taken by the government to help small, poor and MSME’s get access to formal credit channels.

  • Udyam Portal – The only Government Portal for registration of MSME (Udyam) maintained by Ministry of Micro, Small Medium Enterprises that gives the details and steps relating to registration and makes the free of cost and paperless registration process easy for any person.
  • Pradhan Mantri Rojgar Protsahan Yojana (PMRPY) – Under the scheme, Government of Bharat is paying Employer’s full contribution i.e. 12% towards Employees’ Provident Fund (EPF) and Employees’ Pension Scheme (EPS) both (as admissible from time to time) for a period of three years to the new employees through Employees’ Provident Fund Organisation (EPFO). As on 3rd March, 2021, benefits have been provided to 1.21 crore beneficiaries through 1.52 lakh establishments.
  • Aatmanirbhar Bharat Rozgar Yojana (ABRY) – The scheme has been launched to incentivize employers for creation of new employment along with social security benefits and restoration of loss of employment during COVID-19 pandemic.
  • E-Shram Portal – Bharat’s first national database of unorganised workers. It facilitates extending benefits of social sector schemes to the workers in an unorganised sector. More than 5.3 crore unorganised workers have registered until 30 Oct’21.  The rate of formalisation of unorganised labour due to E-Shram is around 15% / Rs 6.4 lakh crore / 3% of GDP in just 2 months. There has been an estimate Rs 4.6 lakh crore formalisation only through KCC route in agriculture.
  • Last but not the least, digitalisation has pulled in the cash- based workers to make easy transfers of money through Paytm, Google pay, Phone pay and UPI transactions. The informal sector has accepted financial reforms without much reluctance.


Can self-reliant Bharat roadmap be planned without informal workers? Perhaps, no! But we have begun the journey of transitioning informal into formal economy through plethora of measures and this is going to be a long journey as there is a large chunk of informal segment in Bharat.

Bharat can only progress when informal workers are considered as our strength and only when the workers assist in increasing the productivity and generating wealth for our country. When a country has higher levels of informality, the government is bringing in less revenue far below its capabilities compared to developed nations.

Therefore, formalisation will raise consumption and demand for products and services thereby raising GDP of our country.

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Criti Mahajan
Criti Mahajan
An MBA graduate in finance with 5 years of working experience in the financial services space. An enthusiastic research writer inclined towards understanding economics and policy making with an experience of diversified writing on professional platforms in economics. A self-starter, perseverant and an ardent learner.


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