How Formal is the Indian Economy?
Over the last few years, the word ‘formal’ slowly crept into discussions about the Indian economy. I heard comments like this:
“Demonetisation may have been tough for small business, but it succeeded in formalising the Indian economy.”
Or,
“Those who can’t deal with GST documentation are tax evaders. If they perish, the Indian economy gets formalised.”
Or,
“The MSME sector has been hard hit by shutdowns, but the formal sector has done well. See, GST collections have gone up.”
Which they have. GST collections in November, of Rs. 1.30 lakh crore (lc), were the second highest on record. This is seen as evidence that the economy is bouncing back, and that formalisation has led to higher tax collections.
A question I asked myself is, how do you measure ‘formalisation’?
GST collections may be a good place to start, since the belief is that more formalisation equals higher tax collection. Skipping the last couple of years, which were disturbed by COVID, I compared GST collections over the last three months of this year with collections for the same period in 2017. At Rs. 3.59 lc, this year’s GST take was 27% higher than the number for 2017, which was Rs. 2.83 lc.
For a meaningful comparison, we need to adjust the numbers for inflation over these four years. At a rate of 5% a year, inflation accounts for 22% of the growth in GST collections, leaving us with a real growth of 5%, or a little over 1% per annum. This is not a number that suggests that the formal sector of the Indian economy is booming.
The number of registered companies provides a more direct count of the formal sector. I turned to data from the Registrar of Companies (ROC). Unlike individual businessmen or partnerships, all companies need to register with the ROC. Thanks to Akanksha Dutt, who runs the corporate data firm Nexensus, I was able to get data on active companies for the 5 years since 2016.
The largest companies in the country, whether Reliance Industries, or Infosys, are what are called listed public companies, meaning that you can buy and sell their shares on the stock exchanges. Between March 2016 and March 2021, the number of active public limited companies has actually gone down, from 6796 to 6740.
Companies which are not traded on stock exchanges, but are owned by enough people (200 or more) to be called public, tend to be smaller than the listed companies, though there can be exemptions, In the same period, 2016-2021, the number of active unlisted public companies has gone up, from 63568, to 65492. This growth of 4% is under 1% per annum.
Private limited companies, which are generally the smallest kind of companies, have seen somewhat more growth - from 1.02 mn., to 1.23 mn. This is a little less than 4% per annum.
In sum, the headcount number of registered companies shows some growth, but not enough to support the narrative that Indian business has responded to systemic shock by rapidly formalising.
Employment is the data point that most severely challenges the story of growth in the formal sector of Indian business. I wrote about the employment crisis in newsletter #2. The chief features of this crisis are:
Despite population growth, the number of people in the workforce has gone down. Because employment opportunities are limited, many people have opted out of the workforce. This is especially marked for young people, between 15 and 29.
The workforce in agriculture has gone up.
Formal employment, especially in manufacturing, has gone down.
Whichever way you look at it, growth in the formal sector of the Indian economy has been limited, at best. Could ‘formalisation’ then mean that the share of the formal sector has grown, because of degrowth in the non-formal sector?
There is no shortage of evidence that this has been the case. After demonetisation, the All India Manufacturers Organisation, AIMO, put out a widely quoted report of how a shortage of cash was disastrous for small factories. For the last 4 years, I have continuously heard from financial salesmen that the formalisation of the Indian economy is good for equities, as the larger, listed companies are taking market share from the smaller, non-formal companies that have shut down, or shrunk.
Corporate results in 2017 showed a huge bump in the fortunes of Indian listed companies. Both turnover and profits seemed boosted by demonetisation. Many commentators saw this as evidence that demonetisation was good for the economy. While the distress for small businesses was evident, a related issue kept bothering me, namely, that every producer is also a consumer.
Let’s say 10 biscuit factories shut down because they can’t cope with no cash, or with funds tied up in GST returns, or with workers who have returned home. Meanwhile, Britannia keeps running, and supplies the biscuits that the small bakeries once did. Clearly Britannia’s market share goes up, and since its turnover and profits are recorded, so does GDP. Meanwhile, the workers in the small bakeries have lost jobs and income, and so have the bakery owners. Their ability to consume everything, from tea to biscuits, goes down. Yes, Britannia now has a larger share of the biscuit market, but the market itself is slowing, even stalled.
This is exactly what we are now seeing. From Britannia to Hindustan Lever, chief executives of Indian consumer goods companies report a marked slowdown in demand, and warn that it may get worse. Official GDP numbers for the second quarter of this financial year confirm this sense. ‘Private consumption’, or what Indian households spend on their well-being, dropped to Rs. 19.48 lc., between June and September of 2021, from Rs. 20.20 lc in the same period two years ago.
India, or Bharat, we are one nation, and the linkages between farm and factory, between idle village youth and packaged snacks, are deep and real. ‘Formalisation’ is a narrative with a great ring to it, but it is looking increasingly hollow. The bitter truth is that the informal sector has been badly hit, the formal sector less so.
Nasdaq and the Also-Ran
A little over two years ago, in July of 2019, I wrote in the Mint newspaper that US equities looked more promising than Indian equities, and among US equities, I preferred the Nasdaq. Since then, I’ve maintained a log of how one lakh of rupees would have done if I invested it in the leading Indian index, the Nifty, in the US Dow (or Dow Jones Industrial Average), and in the tech heavy NASDAQ.
The Nifty and Dow have kept an even pace, and today that one lakh is worth about Rs. 1.4 lakh in each case. The NASDAQ, however, has had a completely different trajectory, and on November 30th, that one lakh was worth Rs. 2.09 lakh. This is a stellar out-performance by any measure.
Since one doesn’t earn any money by looking at the rear-view mirror, the question to ask is whether this out-performance will continue. I think it will. In 2011, legendary Venture Capitalist Marc Andreesen wrote an article, “Why Software is Eating the world”, that become highly influential. I think that story has a long way to run. Apple and Google have the ability to keep making themselves more and more relevant, and the network effect of Amazon and Facebook will only deepen. When I invest in a consumer start-up in India, I ask myself what percentage of that income will buy advertising on US-based platforms. Answer: A Lot.
In India, too, I would rather put my money into digital start-ups than into listed companies functioning in a 20th century paradigm, but that’s a story - or many stories - for another time. When it comes to the listed space, the Nasdaq continues to be my most preferred equity index.
Jack Reacher
Tom Cruise is a mega-star, but Jack Reacher is the iconic vigilante of the thriller universe. At 6’5” and 250 pounds, he has an eye-stopping bulk, and when he enters a room, he should usher in a distinct chill.
Apologies if you are a Tom Cruise fan, but at 5’7”, there is absolutely no way in which he can make a convincing Jack Reacher. And just to prove how unbiased and objective I am, I refused to watch his two Jack Reacher films, so what if they ended up grossing 400 million dollars.
I feel personally vindicated that Lee Child, author of the Jack Reacher series, went searching for a massive hunk to star in the forthcoming TV series. “Within 2 seconds” of switching on the audition video, he knew he had found him, in Alan Ritchson, who is 6’2”, has a military background, and looks as unstoppable as a Humvee.
Lee Child: "This guy stepped on the screen and had this stillness and blend of menace and goodwill that is always confusing about Reacher"
“Something to watch”, my son said. Every new Jack Reacher novel goes on to our shared Kindle library.
Alan Ritchson
Season 4 has been announced, and they have a new lead. Hopefully, he is less wooden than Mr. Ritchson.
Loved this piece - thanks for affirming my belief in the Nasdaq. And nice to know that you are a Reacher fan too. :-)