Formalisation of India's Informal Economy

Formalisation of India's Informal Economy

#GS-3 #Economy #Employment #Inclusive Growth #Governance & Social Justice #Social Justice #Vulnerable Sections

Key takeaways

  • According to the ASUSE 2025 report, India's non-agricultural unincorporated sector comprises 7.92 crore enterprises employing over 12.8 crore workers.
  • Informal workers account for nearly 90% of India's total workforce and contribute approximately 45% to the national Gross Domestic Product.
  • Climate change impact studies show India suffered an estimated $194 billion in potential income losses in 2024 due to heat-linked productivity declines.
  • Key government formalization initiatives include the e-Shram portal with over 31.78 crore registered workers and the Womaniya initiative on GeM generating over Rs 28,000 crore in public orders.

Why in News

  • The National Statistical Office (NSO) released the Annual Survey of Unincorporated Sector Enterprises (ASUSE) 2025.
  • This report provides the first district-level estimates of India's unincorporated business sector.
  • India's informal economy remains the largest employment provider, but workers face low productivity, limited social security, and low financial access.
  • As a result, policymakers are prioritizing inclusive formalization to protect informal workers while offering them dignity.

Understanding the Informal Economy

  • The informal economy includes all economic activities by workers and businesses that lack sufficient legal or institutional coverage.
  • These businesses operate outside official tax systems, municipal registration networks, and standard labor laws.
  • The International Labour Organization (ILO) defines the informal sector through enterprise ownership rules set during the 15th ICLS 1993.
  • Informal enterprises are household-owned businesses without a separate legal identity that operate below specific size thresholds.
  • The ILO defines informal employment through job characteristics established at the 17th ICLS 2003.
  • Informal employment refers to jobs without statutory social security, written contracts, paid leave, or labor law protections.

Key Characteristics of the Informal Sector

  • Enterprise owners and their businesses share a single legal identity, placing personal assets at direct financial risk.
  • Operations rely heavily on labor-intensive methods, traditional skills, and micro-capital rather than modern machinery.
  • Businesses function without audited double-entry accounting, relying mainly on cash transactions or unrecorded digital ledgers.
  • Workers lack mandatory access to provident funds, health insurance, gratuity, and paid maternity or sick leave.
  • Oral work agreements create job insecurity, arbitrary dismissals, and an absence of formal notice periods.
  • Daily wages, piece-rate earnings, and seasonal fluctuations lead to highly unstable household cash flows.
  • Firms often operate below tax registration limits or within regulatory grey zones regarding labor laws and licensing.
  • Limited collateral restricts access to commercial bank loans, driving business owners toward microfinance or informal moneylenders.

Current Status of the Informal Economy in India

  • Approximately 90% of India's total workforce works in informal employment across unorganized sectors and formal firms.
  • According to the PLFS 2025, self-employed individuals make up 56.2% of total employment, consisting mainly of own-account workers and unpaid family helpers.
  • Casual workers constitute 20.2% of the workforce, working mainly in construction, agriculture, and urban daily-wage jobs.
  • Regular salaried workers account for 23.6% of employment, though many lack written contracts or social security benefits.
  • Data from ASUSE 2025 shows that India has nearly 7.92 crore unincorporated non-agricultural enterprises.
  • These non-agricultural unincorporated enterprises employ over 12.8 crore workers across the country.
  • Own Account Enterprises that operate without hired labor form the majority of these business units.
  • The informal sector generates approximately 45% of India's total Gross Domestic Product.
  • Over 31.78 crore unorganized workers have registered on the e-Shram portal, receiving Universal Account Numbers (UAN) for social security delivery.
  • The share of informal establishments using the internet rose from 26.7% in ASUSE 2023-24 to 39.4% in ASUSE 2025.

Emerging Trends in the Informal Economy

  • The rapid growth of app-based aggregators in delivery, ride-hailing, and home services created a distinct gig workforce.
  • While gig work offers flexible hours, it introduces algorithmic management where workers lack minimum wage guarantees and health protection.
  • Widespread adoption of UPI and QR codes creates digital transaction histories for micro-enterprises.
  • These transaction records enable cash-flow credit scoring, helping schemes like PM SVANidhi extend collateral-free micro-loans to street vendors.
  • Formal companies increasingly use fixed-term contracts, staffing agencies, and gig workers to reduce wage bills and pension liabilities.
  • Digital platforms like e-Shram link unorganized workers directly to welfare schemes like PM-SYM pension via direct benefit transfers.

Difference Between Formal and Informal Economy

  • Formal firms register with official statutory bodies and tax networks like GST, while informal units remain unregistered and operate below legal thresholds.
  • Formal workers receive statutory social security like EPF and ESI, whereas informal workers lack mandatory employer-paid benefits and paid leave.
  • Formal jobs offer legally binding written contracts with notice periods, while informal employment relies on verbal agreements with high firing risks.
  • Formal wages follow statutory minimum wage rules, while informal wages fluctuate based on market supply, daily rates, or piece-rate systems.
  • Formal businesses use capital-intensive machinery to generate higher Gross Value Added per worker, whereas informal units rely on low-productivity traditional technology.
  • Formal companies secure institutional bank credit using audited balance sheets, while informal units depend on moneylenders or personal savings due to credit barriers.
  • Formal firms pay corporate income tax and GST, while informal units operate mostly outside direct tax regimes due to low revenues and cash transactions.

Major Issues Facing India's Informal Economy

  • A low capital-to-labor ratio keeps informal worker productivity far lower than that of the formal sector.
  • For example, powerloom operators in Surat use second-hand looms that operate at 20% to 30% of the efficiency of air-jet looms in formal mills.
  • Platform aggregators classify workers as independent partners, avoiding traditional employer obligations under Indian labor law.
  • Dynamic pricing, arbitrary penalty deductions, and unilateral payout cuts keep gig workers in a state of income insecurity.
  • The gig workforce is projected to reach 1.2 crore workers, yet the Fairwork India Ratings showed major platforms scored 0 out of 10 on basic fairness parameters.
  • Micro-enterprises face an institutional credit shortage, with the RBI estimating an unmet MSME credit gap of around Rs 80 lakh crore.
  • While PM SVANidhi offers basic micro-credit to street vendors, moving up to larger commercial bank loans remains difficult without physical collateral.
  • Outdoor informal workers face extreme heat stress caused by climate change, leading to severe income losses and health risks.
  • Data from the Lancet Countdown shows India suffered an estimated $194 billion in potential income losses in 2024 due to heat-related productivity declines.
  • By 2030, outdoor informal workers are projected to lose an average of 22.5 working days annually to heat stress.
  • Strict compliance rules can act as a regressive tax, encouraging firms to remain small to avoid regulatory oversight.
  • Over 99% of informal manufacturing and service units operate as micro-enterprises with fewer than 10 workers.
  • According to PLFS data, over 70% of non-agricultural informal wage earners work without a written employment contract.

Government Initiatives for Formalisation

  • The Code on Social Security (2020) unifies nine central labor laws to extend protection to unorganized and gig workers.
  • Digital aggregators must contribute 1% to 2% of their annual turnover to a dedicated Aggregator Social Security Fund.
  • The government approved raising the mandatory EPFO monthly wage ceiling from Rs 15,000 to Rs 25,000, extending coverage to 51 lakh more workers.
  • The Ministry of MSME launched the Udyam Assist Platform (UAP) to give informal units MSME status and access to Priority Sector Lending (PSL) without immediate GST registration.
  • The Account Aggregator (AA) ecosystem allows micro-merchants to share bank statement data digitally, enabling cash-flow-based lending without physical collateral.
  • The PM SVANidhi scheme uses digital transaction records to give street vendors micro-loans starting at Rs 10,000 and stepping up to Rs 50,000.
  • The PM Vishwakarma Scheme provides comprehensive support to traditional artisans and crafts workers following family-based skill models.
  • Over 30,000 artisans under the PM Vishwakarma Scheme have joined digital portals like the Government e-Marketplace (GeM) and ONDC.
  • The Public Procurement Policy for MSEs requires government bodies to buy at least 25% of their annual needs from micro and small units, including sub-targets of 4% for SC/ST owners and 3% for women owners.
  • The Womaniya initiative on GeM helped over 2.1 lakh women-led units and self-help groups secure government orders worth over Rs 28,000 crore.
  • Under PMKVY 4.0, Recognition of Prior Learning (RPL) certifies informal worker skills against the NSQF framework.
  • Digital credentials verified through the Skill India Digital Hub (SIDH) help workers prove their qualifications and access job opportunities abroad through NSDC International.

Way Forward

  • India should introduce a Glide-Path Tax Scheme offering new micro-enterprises 100% tax credits on compliance expenses for their first three years.
  • A simplified single-page filing system for businesses earning under Rs 1 crore annually would eliminate regulatory burdens that cause enterprise dwarfism.
  • Authorities must fully implement the Code on Social Security (2020) by setting up dedicated Gig Worker Social Security Boards.
  • Introducing Algorithmic Transparency Guidelines will audit automated dispatching and penalty deductions, ensuring a basic living wage floor for gig workers.
  • Constructing plug-and-play micro-industrial parks in clusters like Surat or Rajkot would give informal firms shared access to machinery and testing labs.
  • Expanding the National Creche Scheme into community childcare hubs near employment centers would help female informal workers balance care duties.
  • Transforming home-based female workers into formal producer groups with micro-equity funding will increase their income and market bargaining power.
  • Setting a statutory procurement quota requiring 15% of sub-contracted public infrastructure materials to come from newly formalizing micro-units would incentivize registration.
  • Introducing dynamic living wage indexing based on local inflation and housing costs will help adjust wage rates quarterly for casual labor.

Conclusion

  • India's informal economy serves as a critical livelihood base, but productivity gaps and poor social security limit its potential.
  • Combining digital tools, enterprise formalization, universal welfare, and worker rights will convert informality into sustainable economic growth.