India's GDP may be 'underestimated by 15%'

India could be underestimating economic growth to the extent of 15% every year as it struggles to capture the growth numbers for half of its economy striving under the informal sector, according to experts.

The informal sector in India, which contributes to the extent of 50% of GDP and 90% of the workforce, includes micro manufacturing units, agriculture, workers employed by these sectors, and self-employed people like tailors, barbers and so on.

With such a big number outside the tax net, India’s estimation of GDP is as much estimation as calculation, say Neelkanth Mishra and Ravi Shankar, analysts with Credit Suisse in a note.

India’s GDP stood at $1.9 trillion, recording a growth of 5% last fiscal.

“In India, the informal sector would definitely be contributing more. There is a tendency towards under estimation for the simple reason that the coverage is based on the hypothesis,” said Madan Sabnavis, chief economist at CARE Ratings. “There are self-employed people coming under the informal sector on which we don’t have data.”

The ballpark number for underestimation ranges from 5% to 15%, according to economists. India’s informal economy could be the largest informal economy in the world, maybe second only to China. The GDP calculations for the informal sector are based on out-dated assumptions of their value addition to the economy.

The disadvantage of having such a huge informal sector is lower taxes for the people outside government reach and much higher for the people within the formal sector. But economists say tax saving is not the intention or the reason for their existence.

“Unlike in the developed economies where informality is purely a deliberate choice to avoid taxation or regulations, in India it is more structural: a reflection of the lack of development and limited government reach,” Mishra and Shankar said.

The lot of government regulations such as stiff labour laws are keeping companies out of the formal sector, according to A Prasanna, chief economist at ICICI Securities Primary Dealership.

With such a huge informal economy, targeting government programmes for boosting growth and social benefit schemes becomes a tad difficult. India has been struggling with economic growth since US recession struck the world in 2008. The situation has got worse particularly in the last few years with domestic demand also faltering.

The most important constraint that squeezes growth in the informal economy is their lack of access to formal credit. Credit Suisse’s interaction with the Central Statistical Office suggests only 18% of credit to small and medium enterprises is formal.

Labourers and self-employed people find it difficult to obtain land legally, buy insurance and also get bullied into giving bribes.

Due to all these factors, informal sector is left to itself to figure out survival strategies, leading to disorganised urbanisation, massive migration and immense pressure on civic amenities. If India succeeds in getting this huge informal economy into the formal fold, the potential to growth is huge.