Shrinking of India’s Informal Economy: SBI Report

In News

• The State Bank of India Research’s latest “Ecowrap” report stated that India’s informal economy has shrunk to around 15-20 per cent of the formal GDP as against 52 per cent three years ago.

Major Highlights of the report

• Informal agriculture sector shrinks: It has shrunk from 97.1% of the sector’s GVA in 2017-18 to just 70%-75% in 2020-21, driven by the increased penetration of credit through Kisan credit cards.
• Higher formalisation: Measures that accelerated the digitisation of the economy and the emergence of the gig economy have facilitated higher formalisation at rates that are possibly much faster than that of most other nations.
  • At least Rs 13 lakh crore has come into the formal economy through various channels including the recent scheme on the e-Shram portal.
• EPFO payroll report: Based on this data we estimate almost 36.6 lakh jobs have been formalised.
• State-wise data: Four states accounted for 72 per cent of total registrations, with West Bengal on top followed by Odisha and Uttar Pradesh.·         
• Sector-wise data: The informal size of the trade, hotels, transport, communication, and broadcasting sectors, which employ around 17 crore households as per the 2011 census, is 40 per cent.

Issues flagged in SBI Report

• Flaws in Numbers: According to some experts, the informal sector was not 52 per cent but around 42-44 per cent of the GDP and while there has been a rise in formalisation, the informal sector has definitely not halved.
• Tax-to-GDP ratio: In the case of high levels of formalisation, the tax-to-GDP ratio would have gone up significantly. However, it has only gone up from around 16.5 per cent to 17.5 per cent.

Factors behind Formalisation of the economy

• Adoption of GST: As GST is implemented, a paper trail will be established and most companies will not be able to operate unless they are part of the formal economy.
• Application of technology: for developing aggregation platforms of service providers like Amazon, Flipkart, Uber, Ola, etc. These platforms not only create jobs but also lead to the formalisation of the economy. 
• A combination of demonetisation and disallowance of cash transactions:  Above a prescribed ceiling and other steps to reduce the cash intensity of the economy has put the informal sector under strain as these are taking away much of the arbitrage of the operators in this sector. Rules are being framed to compel all units to pay salaries to workers through direct transfer into their bank accounts as today no party in its supply chain wants to deal in large volumes of cash. 
• Simplify tax administration: Tax administration is more often cited as a problem than tax rates. Consider single taxes for MSMEs as a way of reducing the number of payments. Offer different payment options, one-off or by instalment.
• Labour law reforms: These protects essential rights while making it easier to hire and fire workers and to employ people on flexible contracts. 

Benefits of Formalisation of Economy

• Expand the tax base: Reports say that only 1.08% of the total population pays taxes and that’s one number that definitely needs to go up via formalisation of the economy.
• Expanding the benefits: It helps expand many legitimate benefits to millions of workers like EPS, medical etc. The way the unorganized sector employees are left open to exploitation is to be seen to be believed.
• No middlemen: It would help many products find the right markets directly, reducing the imposing middlemen.
• Reduce the gross inequality in income: It would also help reduce the gross inequality in income, one of the things our country suffers from.
• The rise of eCommerce: As barriers of physicality get broken and more and more people move towards e-Commerce, the availability of brands is suddenly no longer an issue. Bigger brands tend to benefit out of all this more than anything else.
• More sustainable jobs: Formalisation would provide higher quality, better paid, more sustainable jobs.
• Reduce the cash economy: and provide more resources for intermediation by the formal financial sector.
• Welfare in some marginalised groups: Formalisation may also increase welfare in some marginalised groups by confirming their right to take advantage of market opportunities.

Challenges in Formalisation of Economy

• Regulatory barriers: are inappropriate requirements stemming from governments that do not appreciate the impact on firms (particularly smaller firms) of additional reporting, inspection and other compliance procedures.
• Administrative barriers: stem from the way regulations are enforced. They include excessive paperwork, inefficiency/delayed decisions, inaccessibility of services, bureaucratic obstruction and abuse of authority.
• Fees and financial requirements: consist of regressive fees that penalise smaller firms, overly complex tax regulations and poor tax and tariff administration.
• Corruption: is a major factor deterring formalisation, as businesses stay off registers and tax rolls in order to minimise contact with corrupt public officials.
• Socio-cultural barriers: In some countries, there is a degree of resistance to formalising because of socio-cultural obstacles. The informal economy comprises strong networks of trust and interdependence, often cemented by collective historical experience.
• Criminality: Some individuals are reluctant to provide information about their personal wealth and circumstances to government officials because they are concerned that this information may be passed to people involved in serious and organised crime and make them targets for criminal activity.

Suggestions towards Lower Informality

• Education: Improving access to and quality of education is probably the single most powerful way to lower informality.
• Tax system: design should avoid inadvertently increasing incentives for individuals and firms to remain in the informal sector. It is generally recognized that simpler value-added and corporate tax systems (with no or minimal exemptions and loopholes) with lower rates, as well as low payroll taxes, help reduce informality.
• Financial inclusion: Policies to enhance financial inclusion by promoting expanded access to formal (or bank-based) financial services can help lower informality. Lack of access to finance is a key constraint for informal firms and entrepreneurs, stifling productivity and the growth of their businesses.
• Structural policies: A range of structural policies can help increase incentives and lower the cost of formalization. Labour market regulations can be simplified to ensure greater flexibility and facilitate informal workers’ entry into formal employment.

Source: TH