A leaner informal sector could mean greater formalization, but remember that this was also the period in which the Indian economy, particularly the informal sector, was battered by some of its most disruptive economic shocks, from demonetization, a chaotic introduction of the goods and services tax, and the covid-19 pandemic.

The 2021-22 and 2022-23 reports of the Annual Survey of Unincorporated Sector Enterprises, released last week, provided data on the size of the sector at nominal prices. However, a follow-up analysis by India Ratings and Research shows that in real (inflation-adjusted) terms, the gross value added (GVA) by such enterprises declined 1.6% between 2015-16 and 2022-23. (The last time a comparable report was released was in 2015-16.)

The analysis also showed that the informal sector's growth had fallen short of its potential due to the economic shocks, costing India an estimated ₹11.5 trillion, or 4.3% of the 2022-23 GDP, over the seven-year period.

India's informal sector consists of a vast network of small businesses, street vendors, and independent workers, operating outside the formal legal framework, and their sheer size—three-fourths of the workforce—means they play a critical role in job creation. The latest survey covered 458,938 informal sector enterprises between October 2022 and September 2023.

Employment woes

The informal sector had grown 7.4% per year in real terms between 2010-11 and 2015-16. Alongside, the number of workers also rose from 108 million to 111.3 million. But as the informal sector shrank in size in the seven years that followed, the number fell to 109.6 million by 2022-23. This was chiefly due to a decline in the size of the informal manufacturing sector, while trade and other services saw increases.

Although this is higher than 97.89 million in 2021-22, the lower level of employment from the pre-shock year is worrisome at a time when job scarcity has emerged as one of India's major economic issues.

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Labour productivity within India's unincorporated sector, as measured by GVA per worker, also paints a concerning picture. The compound annual growth rate (CAGR) for GVA per worker was 12.3% during the period of 2010-11 to 2015-16, which dwindled to a mere 4.6% in the subsequent seven-year period. This means a significant slowdown in the pace of growth in the value of goods and services produced by an average worker in the informal sector.

According to Amit Basole, a professor at Azim Premji University, this tends to happen when people crowd into the informal sector due to a lack of other options, which divides the existing market among more workers, leading to a fall in productivity.

Policy correction

Amid the gloomy scenario in the informal sector, the silver lining is that capital investments have picked up, with fixed assets owned by the sector going up by 4.6% per year between 2015-16 and 2022-23 compared to 2.7% a year in the five preceding years. That improvement could be further tapped through the right policy pushes.

In the past few years, the Narendra Modi government has tried to push for more formalization of the economy and a shift away from cash, and it has yielded some results. But the shocks to the informal sector cannot be ignored.

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"No doubt, formalization of the economy is the way forward, but the reduced footprint of the unorganized sector has implications for employment generation," the India Ratings report said. "Therefore, a judicious mix of policy, which allows co-existence of both formal and informal sectors needs to be pursued in the interim."