Special Economic Zones : Indian Scenario

Article Written By: Amit Abhyankar

Special Economic Zones suddenly find themselves in news in India. They have worked wonders in countries like China. Do they really draw FDI or are just revenue guzzlers? Can China’s model of SEZs help India achieve the similar results? The article tries to find out…

What is a Special Economic Zone (SEZ)?

SEZ is a geographical region with different economic laws than a country’s typical economic laws, with the main goal of attracting foreign investment. In economic terms, SEZ is specifically delineated duty-free enclave and shall be deemed to be foreign territory for the purposes of trade operations and duties & tariffs. Countries which have experimented with this concept are China (with great success), UAE, Malaysia, India, Jordan, Poland, Kazakhstan, Philippines, Russia and to some extent North Korea.

Apart from Central government, any private/ public/ joint sector or State Government can set up an SEZ. Before recommending any proposal to department of commerce, the State must satisfy themselves that they are in a position to supply basic inputs like water, electricity etc.

SEZs have potential to play a key role in economic development of a country, as they did for China.

Success in China

There are currently over 4000 special investment zones worldwide. China started with SEZs in 80’s. After establishing the first Export Processing Zone (EPZ) in Kandla in 1965, India’s exports through EPZs have increased from Rs. 10 lakh to $ 1 billion. Sounds impressive, till one looks at China. China’s first SEZ at Shenzen ‘alone’ attracted over $ 30 billion in direct investment. In countires like China, UAE & Malaysia, these zones have-

(i) emerged as focal points for foreign investments

(ii) attracted over 20% of foreign direct investment

(iii) contributed to over quarter of country exports.

(iv) served as testing grounds for reforms & policies for governments

(v) indirectly, helped improve competitiveness of local industry, job creation, local skill upgradation & technology absorption from FDI.

Indian Scenario

India was one of the earlier starters in SEZ business. The SEZ policy in India first came into inception on April 1, 2000. However with lacunas like lack of central legislation, rigid labour laws, the SEZs in India were not off to a flying start. India has always looked enviously at China’s far larger & more successful zones. Prior to 2005, the policy relating to SEZs, contained in foreign trade policy, was implemented through piecemeal & ad-hoc amendments to different laws, besides executive orders. In order to avoid these pitfalls and to give a long-term & stable policy framework with minimum regulation, the SEZ Act 2005 was enacted. The Act provides the umbrella legal framework, covering all important legal & regulatory aspects of SEZ development as well as for units operating therein.

Land will often be provided by the State governments at concessionary rates, and both developer & operating units can receive tax holidays up to 15 years, provided they are export-oriented. The other important provisions include single window clearance mechanism for the units in the zone; fiscal regime for developers & units besides a legislative framework for setting up offshore banking units; unit being eligible to 100% tax exemption for first 5 years, 50% for the next 5 years and 50% of the ploughed back export profits for the next 5 years. The developers will continue to get 100% income tax exemption for 10 years in a block period of 15 years.

The aim is to enhance foreign investment, provide an internationally competitive & hassle-free environment for exports, boost industrial investment & exports and to generate employment while persuading the private sector to build social infrastructure that the states cannot afford. E.g. Reliance has announced to develop 10,000 hectares of prime land adjacent to Gurgaon, a satellite city on the outskirts of Delhi. The government hopes that the SEZs will bring in billions of dollars in investment and create over a million new jobs. India already has 11 functioning SEZs- 7 set up by the central government and 4 by private/joint/state sector. These 11 SEZs are functioning in- Kandla, Surat, Cochin, Santa Cruz, Falta, Chennai, Vishakhapatanam, Noida, Indore, Salt Lake (Kolkata) and Jaipur. Two others at Jodhpur & Moradabad are ready for operation. Already they generate 5% of total Indian exports! The Board of Approval in the Commerce Ministry in its three meetings so far has approved 150 proposals (out of nearly 380), less than 6 months after the SEZ Act. The list of bidders includes private players like Reliance, Wipro, Infosys & even public sector giants like ONGC. Reliance’s project of Maha Mumbai SEZ is going to be the largest project of SEZ in entire world by any private player. In July 2006, concerned over the proliferating SEZs, the government, against wishes of Commerce ministry, decided to put the upper limit to number of SEZs in India, and accordingly a cap of 150 was imposed. In this battle of finance & commerce departments, the later had the last laugh, as recently government lifted the proposed cap.

India & China: The Scenarios Compared

India has more or less adopted the same China model of SEZ development and expecting the similar results. However, the government is missing out on few vital differences:

(i) Free zones in countries like China, UAE were mostly public funded in which economic gains prospects assumed far more significance than financial viability considerations. Thus the responsibility of market to promote zones & to attract tenant industries was primarily shouldered by governments. The Indian model, on the contrary, envisages ‘private sector led’ development of such zones. Thus, the responsibility or risk of financing, marketing & promotion has been vested with private players, who have very little or no experience in these areas.

(ii) India is not a command economy i.e. foreign investors are not confined to SEZs only, which make these zones little special than were China’s where SEZs used to be the only route through which foreign investors could enter the country. Besides, Indian has no equivalent to Hong Kong or Taiwan where industries had a pressing need to relocate and China served as a ready relocation base.

(iii) China continues to score because it has bundled an attractive tax environment with world-class infrastructure and a liberal labour environment. In India, on the other hand, buckling under the pressure from Left parties, the government has axed the Section 50(b) from the central SEZ bill, which would have empowered states to ease labour laws in SEZs. Democratic India has strong labour unions organically linked to political parties. Authoritarian China, conversely, has very pliant unions. Here India has lost a crucial edge in the global environment marketplace.

(iv) India has also some advantages over countries like China. It has significantly larger English-speaking workforce than does China. India also has an edge in a number of key knowledge based industries like software, IT-enabled services, medical services, drugs & pharmaceuticals & agro-based industries. Hence India’s SEZs are therefore likely to develop along quite different lines from China’s. Indian zones will more likely attract investments in high-end human skill based industries & services sector.

(v) Also in the light of the increasing economic engagement of India with the ASEAN & China, it is more likely that a greater proportion of investment into Indian zones could come from these countries than from US or Europe.

Areas of Concern:

With the mushrooming of SEZs across the country, the RBI has cautioned the government on the revenue implications that could arise from such zones. Though SEZs would boost investment & economic growth, they could also aggravate the uneven pattern of development by pulling out resources from less developed areas.

As mentioned above, the role of the State government is vital in development of these zones. However, different State governments differ markedly in the quality of their vision, their capacity of build infrastructure & the political constraints under they operate. Thus development of these zones say in Gujarat and in West Bengal is going to be on different lines.

There were also allegations that a large portion of agriculture land was being converted into SEZ zones. This statement however holds no ground as total proposed area for SEZs is about 75,000 hectares, only 0.000625% of India’s total area under cultivation. Yes, the only concern is proper rehabilitation or reimbursement of the farmers losing their cultivated agricultural land for the project. Because Government estimation of value of land property is always less than the market price. However, the huge cry over the fear of so called ‘massive land grab’ seems, for me, entirely unfounded. When one weighs the advantages the SEZ is going to bring in, the sacrifice of that much cost sounds justifiable. Reliance’s SEZ project ‘Maha-Mumbai’ is caught in bit of troubled water over the allegations of such land-grabs. However Reliance assures that the project will bring in nearly 5 lakh jobs. There would be civic facilities like schools, hospitals etc. A new generation will grow along with such SEZs, it is argued. 

P Chidambaram’s worry is that development of SEZs and the consequent tax relief would result in unjustified loss of tax revenue (over Rs. 70,000 crore) due to direct tax drain. RBI echoed his view when it cautioned that the revenue loss for the government in providing incentives may be justified only if the SEZ units ensure forward & backward linkages with domestic economy. The Commerce Ministry has, however, denied these implications contesting that in fact government stands to gain Rs. 44,000 crore from them. It said government would also gain from sale of goods from SEZs to domestic tariff area as import duties would have to be paid and these would be on finished products & not on raw material that units will import duty-free. It defended the tax concession to exports by units in SEZs saying that the units in domestic tariff area were already getting such concessions.

Conclusion

Many experts have expressed concerns over the philosophy of sops boost exports. By now however government seems to be realizing the need for formulating a new Indian model of SEZ. India has in fact, the right mix of factors such as availability of large & skilled workforce, intrinsic comparative advantage in several industries, a strong policy framework, availability of complementing & supporting ancillary industry, an already buoyant export sector & vast local markets. SEZs can combine these factors into a powerful alchemy to power investment creation. Unless remedies can be found out to loosen prevalent rigid labour laws, the SEZs cannot be looked at as a panacea for all economic diseases. Opinions are divided on the benefits of SEZs. We would have to wait & watch. Time will definitely have the answer.

 

 

I’ve received couple of inquiries as to the SEZ Act, 2005. Hence for those interested in going through the Act itself, I have included ‘The Special Economic Zones Act, 2005’ in PDF format. Click here to download the Special Economic Zones Act, 2005.

For those interested in reading the SEZ Rules, 2006, the PDF File can be downloaded from here.