What caused India's Informal Economy to shrink?

Economy Nov 07, 2021

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A part of the economy which is not taxed in any form by the Government. The GDP(Gross Domestic Product)of the country does not include the activities of the informal economy, unlike the formal economy.

According to the IMF(The International Monetary Fund), the sector contributes one-third to low and middle income nations,15% to the advanced nations.The ILO(International Labour Organization)says that 60% of the world's employed population stays in the informal sector.


A recent report by SBI’s Economic Research department had said that the share of India’s informal economy has dipped sharply in 2020-2021 from 50% to 15-20%. It may have shrunk to no more than 20% of the economic output. This shows a greater shift towards the formalization of the economy.

According to SBI,80% of the Indian economy has been formalized in 2021 and is seen as a positive development in India’s economy. The formal economy has seen at least 13 lakh crore in the last few years. Almost 36.6 lakh jobs had been formalized till August 2021.

SBI also refers to the 2011 report saying that the informal size of hotels, trade, transport and communication, broadcasting was about 40% of the total informal sector. About 34%of the construction sector,20% of manufacturing sector,16% of public administration was informal.

Due to the significant formalization efforts of the Government, the informal sector is nil in areas like real estate, agriculture, finance, insurance, utility services does not seem to match with the ground reality.

The SBI refers to the EPFO(Employees Provident Fund Organization) payroll data to say that 36.6% of jobs have been formalized, the use of the kisan credit cards has increased significantly from Rs.96,578 per card in 2018 to Rs.1,67,416 per card in 2022. About 4.6 crores have been formalized due to increase in debt of these credit cards.

The EPFO payroll data, debt of kisan credit cards are not reliable factors of formalization. Also, a  13 lakh crore formalization does not mean that the formal economy has jumped from 48%-80% as the size of the Indian economy is 225 lakh crores

The informal sector has been under policy attack through demonetization, G.S.T(Goods and Services Tax) in the view that its operations are illegal and evading taxes. No reforms have been implemented by the Government to reduce informality in the Indian economy.

Reforms to increase the economy formality by IMF:

1. Providing access and improving the quality of education.

2. Simple corporate tax system with a lower tax rate.

3. Easy and expanded access to bank finance.


The condition of today’s Indian economy does not match with the State Bank’s claim of 80% increased formalization. Sustainable development seeks a reduction in informality as it pushes millions of Indians to poverty.

The massive increase in inequality has contributed to the rise in the informal sector and not in reduction as claimed by SBI’s report.

Digitization and GST has made the Government see the sector as a source for tax collection. This will not be effective if the profits and income are missing from the sector. Though Digitization and GST made the informal sector transactions visible to the Government, formalization of the economy did not take place.

Reforms must be implemented by the Government to reduce informality in the Indian economy.

This article has been written by Renitha for The Paradigm.

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