The formal-informal divide

It is now well recognised that there is an investment slowdown in India, which is delaying a full-blooded recovery in the economy. Private investments, the principle engine of growth, are out of steam. The fall is so severe that it has more than offset the government’s macroeconomic stimulus of increased public investments.

The slowdown started five years ago, and is, as Economic Survey 2018 notes, the most severe in India’s history. Investments peaked 11 years ago. The Survey recommends urgent prioritisation of investment revival to arrest more lasting growth impacts, with policy focus on both big and small companies, creating a conducive environment for the smaller industries to prosper and invest, with their ‘animal spirits’ conjured back. That will not be enough to restart the private investments cycle.

Why the slowdown

A day after the Survey came out, estimates of investments and savings in the financial year ended March 2017 were released. The private investments slowdown is statistically visible chiefly in the informal segment of the economy. The corporate sector is not the source of the decline.

Corporate investments have been on the upswing, rising through the five-year slowdown. Financial stress on company balance sheets and the severe bad debt problem is visible only once, when, in 2014-15, companies applied brakes on their investments. The rate rebound the subsequent year. By 2016-17, corporate investments were greater than at the time the slowdown started.

There is negligible change in the investment behaviour of public and private finance corporations. Public non-financial corporations reduced investments marginally. The government stepped up its investments, but its share of the pie is small (with multiplier effects on the rest of the economy).

The sharpest pullback has been by the household sector, its investments are down 6.6 percentage points since the start of the slowdown. Economy-wide investments are down 5.8 percentage points. The slowdown is mainly because of the household sector’s troubles.

The private investments slowdown, then, is a slowdown in the household sector’s investments. The bad bank loans mess appears to have restricted the funds supply to this sector, not corporates.

When will the slowdown end? The estimates show that the slowdown did not deepen in 2016-17, as investment rates for the household sector and the overall economy held steady. If and how demonetisation and the goods and services tax (GST) roll-out altered this, it remains to be seen. Because of the lag in estimation, only some of demonetisation’s initial impact could have got measured. The GST was rolled out in July 2017; the estimates cannot say anything about its impact.

Policy implications

What is the household sector? Households can be producing or non-producing, in which case they are consuming households. The 73rd round of the survey by the National Sample Survey Office had found about 6.34 crore unincorporated non-agricultural enterprises in the country. A chunk of private investments is undertaken by these firms that often operate out of homes, with, typically, less than 10 workers.

The investments estimates (Gross Fixed Capital Formation) cover physical investments in plants, machinery and equipment, and dwellings and buildings, but not land. The two largest investing segments in the economy, households and private non-financial corporations, correspond roughly to the informal and formal economies.

The formal-informal divide shows up also in savings. Corporate savings are rising consistently, while those of the household sector are slowing.

What has made the informal sector more vulnerable than the rest of the economy? Consuming households tend to be net savers. The government, corporates and unincorporated enterprises are net debtors. The savings are mainly held with banks and insurance companies, etc. Through bank loans, bonds, etc, the net debtors raise funds from the savings pool. When the government (Centre plus the States) mops up larger portions of what net savers can provide, corporates can still access capital, but the unincorporated are left without recourse.

Corporates can, and have, borrowed overseas and raised funds from the capital markets. The informal sector has not had the sophistication or resources required. It depends solely on the domestic pool of savings, largely through bank loans, to finance its investments.

The government’s borrowings from the savings pool, after the surge in the fiscal deficit during the United Progressive Alliance government’s tenure, followed by recklessness also of some States, seem to have crowded out the unincorporated enterprises or the informal sector. Banks, hit by the bad loan problem, have played safe. They have lent more than they are statutorily required to the government. As government borrowings dried up the bank credit supply to the informal sector, it has struggled to find funds and has had to cut back its investments.

Given the anatomy of the private investments slowdown, a macroeconomic stimulus may not be the best policy choice. Urgent fiscal deficit reduction, quick clean-up of the bad loans mess, and restoration of banks’ health are more likely to revive private investments.

The informal sector’s character and constraints are different from those of incorporated firms. A policy skew in favour of the vocal and the organised who are able to make themselves heard and seen is natural, but must be shed. The government’s mandarins must pay attention to the unorganised.

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Printable version | May 15, 2022 8:29:15 am |