Informal economy surpasses formal sector in Nepal: Urgent measures advocated for reduction

KATHMANDU: In a startling revelation, a study conducted by the Central Department of Management under Tribhuvan University exposes the informal economy in Nepal, surpassing the formal sector in size. Over the past 11 years, the average size of the informal economy has reached 42.66 percent of the Gross Domestic Product (GDP), marking a significant economic paradigm shift.

According to National Income Accounting, the average size of the informal economy from fiscal year 2010/21 to 2020/21 stood at 42.66 percent. In the fiscal year 2020/21 alone, it constituted 38.66 percent of the GDP, equivalent to Rs 1,441.78 billion of the total GDP, which amounted to Rs 3,733.27 billion.

The study deems an informal economy ranging from 29.8 percent to 37.5 percent as appropriate, according to the International Monetary Fund. Surpassing this range poses risks for the country, urging the need for a detailed study to measure the size of the informal economy, particularly in the wake of economic changes post-2015.

Shivaraj Adhikari, Chief of the Central Department of Economics, attributes the informal economy’s expansion to factors like frequent policy changes, high bank interest rates, and the impact of the Covid-19 pandemic. He stresses the necessity of a thorough study to obtain precise data about the informal economy, also known as the black economy, underground economy, shadow economy, or parallel economy.

Utilizing the Currency Demand Approach and National Income Accounting methods, the study highlights the informal economy’s growth, especially in sectors not covered by national accounts. Despite National Income Accounting suggesting a gradual decline in the informal economy, it surged in the past two fiscal years.

Major sectors contributing to the informal economy include agriculture, where 96.48 percent of the sector operates informally, and real estate transactions, with 99.97 percent falling under the informal economy. Land transactions are identified as a medium for utilizing black money, leading to significant revenue evasion.

Similarly, 50.42 percent of the housing and food services sector operates informally, primarily due to the prevalence of family-run lodges and tea shops that remain unregistered with government institutions.

Prof Dr. Kusum Shakya, the dean of Tribhuvan University, notes that the Covid-19 pandemic played a role in the growth of the informal economy, with women increasingly joining the labor force during the crisis.

While some argue that the informal economy is shrinking as more businesses formalize their registration, economic expert Dilli Raj Khanal stresses the need for simplifying the taxation system to encourage more businesses to enter the tax net.

The revelation of the informal economy’s dominance emphasizes the critical need for strategic measures to gradually reduce its size, fostering a more balanced and sustainable economic landscape in Nepal.