India’s Informal Economy and the Global Recession

Reprinted from Harvard Business Review, May 8, 2009. Click here for original.

I attend many conferences on India. Until 2009, every event depicted the Indian economy as a tiger, one of the Asian economies poised to shine. This year, against a backdrop of global recession, conference titles started to shift: India: A Tiger or an Elephant? But while the country has experienced a growth slowdown, it is nevertheless positioned to weather the harsh economic conditions and to thrive.

There are four distinct characteristics of the Indian economy that soften the impact of today’s conditions: demographics, regulation, exports, and the informal economy.

First, India’s demographics are favorable to growth. It’s a young country with low dependency ratios. Millions of Indians under the age of 30 are slowly receiving better access to healthcare and education, which enables younger Indians to drive the economy by virtue of middle class growth. They will become consumers, spend discretionary income, and enjoy the associated status. This growing middle class will continue to create large levels of domestic customer demand for goods and services.

Second, the fall of Satyam may turn out to be a blessing in disguise for India. The scandal has intensified calls in the country for greater financial transparency, corporate governance, and shareholder activism. Furthermore, the swift and strong response by the country’s regulatory agencies has provided global investors with a positive signal that the Indian government, while not perfect, is dead serious about smart financial regulations and accountability.

Third, the Indian parliament is on the verge of passing a bill that would create hundreds of special economic zones (SEZs) around the coastal perimeter of the country. These zones provide the Indian government a vehicle with which to attract significant foreign direct investment (FDI) from overseas and indigenous multinational corporations (MNCs). The SEZs, while not without controversy, are attractive to global investors for their favorable land policies and generous tax incentives. In the global race for FDI, India’s SEZs could afford it an unmatched competitive advantage among other emerging economies.

Finally, and most critically, the country’s vibrant informal economy, in which goods and services have been traded in the absence of official markets for hundreds of years, affords India’s overall economy an invaluable — and unique — layer of protection. While traditional development and financial statistics estimate Indian market segments for the global business community, these analyses rarely capture the true weight of this economic activity, which by nature is difficult to approximate.

As the global recession affects its foreign direct investment inflows and exports, India’s informal economy acts as a piece of elastic, connective tissue that picks up slack in the system and provides markets for goods and services that may not have been otherwise traded given the circumstances. The existence of this informal economy combined with an emerging middle class, a growing financial regulatory environment, and the creation of more SEZs makes India uniquely situated to survive the current economic storm, no matter if it is a roaring tiger or a slowly moving elephant.