Source: E-mail dt. 21.12.2012


Formal Credit for Informal Sector - Reducing Unemployment


Dr. S. Rajamohan

Professor, Alagappa Institute of Management, Alagappa University, Karaikudi




Mr. D. Durairaj

Ph.D Research scholar, Alagappa Institute of Management, Alagappa University, Karaikudi




Unemployment as one of the macroeconomic problems could be reduced through the formal credit for informal sector participation provided it is well supported and managed. The informal sector in itself may not be able to achieve much as we have presently due to inaccessibility to credit, but with the on-going policy of the Federal Government through the Reserve Bank of India on micro-financing the macroeconomic objective of reduced unemployment, if not full employment will become a reality in India. The microfinance policy has empowered the many microfinance/ banking institutions to provide credit to the informal sector. Therefore the Government of India and all relevant stakeholders continue in their mission towards reducing unemployment while they give their whole support, in making sure that the informal sector continues to enjoy access to formal credit to finance its activities and accomplish its goal of unemployment reduction.


Key words: Credit, Unemployment, Informal sector




Unemployment is one of the developmental problems that face every developing economy in the 21st century. International statistics portray that industrial and service workers living in developing regions account for about two-thirds of the unemployed.


The Indian economy since the attainment of political independence in 1960 has undergone fundamental structural changes. The domestic structural shifts have however not resulted in any significant and sustainable economic growth and development. Various sources show that the Indian economy grow relatively in the greater parts of the 1970s, with respect to the oil boom of the 1970s, the outrageous profits from the oil boom encouraged wasteful expenditures in the public sector dislocation of the employment factor and also distorted the revenue bases for policy planning. This among many other crises resulted in the introduction of the structural adjustment programme (SAP) in 1986 and the current economic reforms. The core objective of the economic structural reform is a total restructuring of the Indian economy in the face of population explosion.


However, these economic and financial structural reforms put in place have not yielded significant results. In the light of this, this paper seeks to examine how a major macroeconomic variable, unemployment could be reduced through the informal sector which is a recent global issue targeted at empowering people towards being self productive and independent. This explain the concepts of informal sector, unemployment in India, segments of informal economy, reasons for unemployment, unemployment rate in India, informal sector employment in India and so on, while we improve our formal credit for informal sector can be activated in order reduce unemployment in India, which will invariably result in reduce poverty, improve standard of living, improve productivity, and an overall improvement in economic performance among other benefits.




Informal sector in India is broadly characterized as consisting of units engaged in the production of goods and services with the primary objectives of generating employment and incomes to the persons concern. These units typically operate at low level of organization, with little or no division between labour and capital as factors of production and on a small scale. Labour relations, where they exist, are based mostly on casual employment, relationship or personal or social relations rather than contractual arrangements with formal guarantees. Thus, production units in informal sector are not constituted as separate legal entities independently of the household or house hold members that own them and for which no complete sets of accounts are available which would permit a clear distinction of the production activities of the enterprises from the other activities of their owners. The owners of their production units have to raise the finance at their own risk and are personally liable, without limit, for any debts or obligations incurred in the production process. Expenditure for production is often indistinguishable from household expenditure. For statistical purpose, the informal sector is regarded as a group of production units, which form part of the household sector as household enterprises or equivalently, unincorporated enterprises owned by households in India.


Segments of Informal SECTOR Economy



activities of informal sector





The informal sector plays a significant role in the economy in terms of employment opportunities and poverty alleviation. This sector generates income-earning opportunities for a large number of people. In India, a large section of the total workforce is still in the informal sector, which contributes a sizeable portion of the country's net domestic product.


The informal sector in India refers to productive institutional units characterized by a low level of organization with no access to formal credit, little or no division between labour and capital, labour relations based on casual employment and/or social relationship, as opposed to formal contracts, labour-intensive technology, and low-skill labour. These units to a large extent belong to the household sector and cannot be associated with other organizations.


According to economists, the labour absorption capacity of the informal sector is much more than its formal counterpart. Thus, with passage of time and further liberalization and globalization of the economy, the informal sector is expected to absorb more labour than the formal sector.




It is surprising to note that despite a decade and a half of economic reforms and rapid progress in the banking sector, India's informal sector, particularly the rural segment, still has very limited access to formal finance. As per a World Bank survey on accessibility of finance in the rural sector, 70 per cent of the rural poor do not have a bank account and 87 per cent have no access to credit from a formal source.




The informal financial sources generally include funds available from the family or moneylenders who operate outside the legal and policy framework of banks. Apart from this, the chit fund is another form of credit source operated by groups of people for mutual benefit; but this approach has its own limitations. The loans are granted mostly without collateral and lengthy documentation formalities as the lender depends mainly on the personal knowledge of, and contact with, the borrower. However, over the years, a few NGOs have engaged themselves in activities related to community mobilization for savings and credit-related operations targeted at some groups in the rural sector.


It has been observed that with a few exceptions, most micro-finance institutions (MFIs) in India are small, region-specific and with a limited collective outreach except a few, and  most MFIs also offer a limited range of financial services beyond credit. This needs a serious policy attention in the light of the fact that in many places, especially in Indonesia and Bangladesh, MFIs operate on a larger space.




Considering the problems faced by the rural people in getting adequate finance at a reasonable rate in a transparent manner there are two options. Banks in India need to,


(i)                 Develop more customized as well as flexible loan products specifically catering to the needs of this sector, and,

(ii)               Develop new delivery channels for lending to the informal sector directly and indirectly. Banks can appoint some business correspondent agencies, such as NBFCs (non-banking finance companies), reputed NGOs, MFIs and cooperatives, for this.


These intermediaries can identify and disburse of small loans in the rural areas for farming or personal purposes. As these business correspondents are basically from the local areas, they can be expected to be more aware about the activities and have other relevant information of their borrowers than any bank officer. By this can be addressed the uncertainties about the quality of borrowers and of the assets. This will help banks in risk mitigation, as a bank's risk will be exposed to the business correspondents only. With proper selection of these business correspondents this risk can also be reduced significantly.


Without opening a full-fledged branch in the rural areas, banks can increase their business through this approach, which reduces the cost of operations. Simultaneously, considering the risk factors of lending to this sector, banks can charge comparatively higher interest rates and earn higher returns. Thus, bank finance to this informal sector through the above route is a win-win situation for both banks as well as the rural economy. Apart from steady flow of finance to Rural India, banks can increase their margins by higher return on assets and lower cost of operations.




Considering the huge demand for funds in the informal sector, the business correspondents, in view of their existing spread, may not be sufficient to fill the gap of fund requirement in this sector. Banks cannot replace the moneylenders, who are present at every nook and corner of the rural sector. Though apparently the interest rates charged by them are comparatively high, taking into account the risk factors, such as poor quality of security, lack of proper records, incidence of high degree of crop failure,  it can be said that from an economic point of view the moneylender still plays a vital role. They are aware not only of the quantum of finance required by the rural people but also the timing. Thus, considering their importance in the informal sector, moneylenders must be co-opted as a business correspondent to the banks.


The interest rate to be charged and the scope of finance are to be decided by the banks. This mechanism brings some degree of transparency to the operations of moneylenders and simultaneously larger flow of funds to be channeled to the informal sector at a reasonable rate. If the moneylenders can be brought into the formal financial system, this is likely to avoid a social tension as well.




The lack of adequate finance in the informal sector is one of the important problems in a growing and developing economy like India.


The success of graduating from a developing to a developed economy, to some extent, depends upon the degree of integration between informal and formal sectors. Considering this and taking into account the immense contribution of the informal sector to the country's growth process, there is an urgent need for policy-makers, financial institutions and banks to take the initiative to ensure that the informal sector gets adequate finance at reasonable rates.

Developing a new financing mechanism by bringing in the informal agents/intermediaries into the finance mainstream will help the informal sector and thereby the overall economy of India.




            The problem of unemployment has becoming a colossal. Various problems have caused this problem. There are individual factors like age, vocational unfitness and physical disabilities which restrict the people. External factors include technological and economic factors. There is enormous increase in the population. Every year India adds to her population afresh. About 5 million people become eligible for securing jobs. Business field is subject to ups and downs of trade cycle and globalization. Economic depression or sick industries are often close down compelling their employees to become unemployed.


Technological advancement contributes to economic development .But unplanned and uncontrolled growth of technology is causing havoc on job opportunities. The computerization and automation has led to technological unemployment. Strikes and lockouts have become inseparable aspect of the industrial world today. Due to these industries often face economic loses and production comes down. Since workers do not get any salary or wages during the strike period they suffer from economic hardships. They become permanently or temporarily unemployed.


Today young people are not ready to take jobs which are considered to be socially degrading or lowly. Our educational system has its own irreparable defects and its contribution to the unemployment is an open truth. Our education does not prepare the minds of young generation to become self-employed on the contrary it makes them dependent on government vacancies which are hard to come.




The unemployment rate in India was in various reported portrays at 9.4 percent in 2009/10 fiscal year. From 1983 until 2000, India's Unemployment Rate averaged 7.20 percent reaching an historical high of 8.30 percent in December of 1983 and a record low of 5.99 percent in December of 1994. The labour force is defined as the number of people employed plus the number unemployed but seeking work. The non-labour force includes those who are not looking for work, those who are institutionalized and those serving in the military. Below the chats shows the unemployment rate in india 

The chart portrays percentage in unemployment rate in India. From the early days it was low percentage of unemployment rate in India, after 2000 its big challenges of unemployment. Through the chart we can understand in the year’s 2008 to 2010 highest employment rate in India. 


Informal Employment


Employees are considered in informal employment when 


o          Their employment relationship, in law or practice, is not subject to:

n            National labour legislation, Income taxation, Social protection or

n            Entitlement to certain employment benefits such as, paid annual leave, sick leave, and so on


Estimates of Employment in India


Table 1 Estimates of Employment in India


Industrial Category

No. of persons (in millions)


Formal Sector

Informal Sector







Mining & Quarrying






Electricity, Gas And Water






Trade, Hotels And Restaurants



Transport, Storage & Comm.



Financial Services



Community Services



All Sectors


(93%) 370.37

Source:  India Ministry of Labour


The table 1 gives details of estimated employment in India, based on the formal and informal sector. From the informal sector provide maximum level of the employment opportunities (238.87 millions) of the population, compare to other sectors. In order to we improve informal sector by all the way, it provide (95 percent) plenty of job opportunities. 


Table 2   Labour Force Characteristic



Share (in percentage)




1. Employed




2. Unemployed




3. Labour Force (1+2)




4. Not counted in the labour force




5. Working age population (3+4)




6. Non-working age population




7. Population (5+6)





















Share (in percentage)




1. Employed




2. Unemployed




3. Labour Force (1+2)




4. Not counted in the labour force




5. Working age population (3+4)




6. Non-working age population




7. Population (5+6)






















Source:  India Ministry of Labour


The table 2 explains labour force in india, it categorized according to area wise and based on gender. From the table majority of the male categories 51.8 percentage is employed and 2.4 percentage unemployed compare to higher than the female categories14.7 percentage.




Employment generation has been seen as a means of alleviating poverty, increasing the level of economic activities which translate into economic growth. The situation of unemployment in India increasing high, however Our State right from the beginning of Five year plans has introduced several employment generating schemes and programmes over the years but in the absence of proper implementation and monitoring have failed to achieve the required targets. Recently UPA Government has come up with National Rural Employment Guarantee Schemes (NREGS) program which aims to provide minimum days (100 days) of employment to people living in the villages. This is a laudable programme if implemented sincerely because it provides employment to people during natural calamities like drought, floods etc. The remedial measures for reducing unemployment may lay greater emphasis on creation of opportunities for self -employment, augmentation of productivity and income levels of the working poor, shift in emphasis from creation of relief type of employment to the building up of durable productive assets in the rural areas and instead of attempting to revert somewhat to protectionist policies the pace of privatization may be accelerated. We therefore examine how unemployment can be reduced, by expanding the activities of the informal sector. Although the informal sector has its challenges, which revolves round the inaccessibility of credit to finance its activities, through the formal credit for the informal sector surely we can reduce the unemployment.




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