SPECIAL ECONOMIC ZONES -RATIONALE AND PROSPECTS
A discussion of special economic zones in India will necessarily involve certain subjective assessments of the policy rationale, its impact and implementation, based on the experience of other countries where such policies have been implemented for a long period and the views of experts who have analyzed the implications thereof. Some postulates and predictive thinking may be inescapable in view of the absence of direct local experience.
SEZ is not necessarily a term that has a definitive connotation though, over years and based on the approach of many countries, it has come to signify certain well-identified features. It is not improper to use SEZ in the place of terms like EPZ (export promotion zone) and FTZ (free trade zone). All these provide or impart slightly differing policy flavours to what is otherwise a ubiquitous concept.
Broadly SEZ has certain defining features such as special tax incentives; duty free movement of goods and services; world-class infrastructure; construction intensive nature; export orientation; differentiated economic management like relaxations in certain basic restrictions applicable to the rest of the economy; and free inflow of foreign capital.
The above are not official definitions but no one familiar with the concept of SEZ, can deny these features. It is important to appreciate that such zones have regulations on the activities carried on, and are not to be mistaken as areas that do not have any form of restrictions. It is often a controlled economic environment for free trade.
According to an article written in 2000 by Robert C Hayword, Director, World Economic Processing Zones Association (www.wepza.org). The concept of free economic zones dates back to 300 BC. The author notes that such enclaves were found in the Phoenician city of Tyre in the Greek island of Deles. The city became very wealthy as a result of such policies and was viewed as a challenge to the centralism of the Roman Empire.
According to the Wepza website, more than 2,000 zones are said to exist in over 120 countries. These are found in various countries following all known systems of economic management. They are in high, low and middle-income countries, having capitalist, socialist or communist oriented economies. Such has been the irresistible pull of the concept to promote economic growth.
The evolution of these zones owes to the fact that traditionally governance has sought to apply much rigidity to the way business is conducted and governments have sought to relax this in designated zones to promote specific forms of economic activity. China was possibly the most closed and authoritarian economic system in the world in the 1970s and early 1980s. It could not liberalize its economy, as its political system did not allow it. So, it created pockets of economic freedom in the form of SEZs, which at times exceeded some small countries in their geographical spread. These pockets were a world apart from the rest of the country in terms of economic system and philosophy. Similar is the example of Dubai, a part of the Emirates that almost exists as art SEZ in itself, though it also has also designated areas like the Jebel Ali Zone.
Ironically, world bodies responsible for administering and advocating global policy initiatives such as the IMP, World Bank, OECD and 110 have reservations about the benefits of such exclusive economic enclaves that liberalize selectively but involves costs for the economies in the form of revenue losses and regional imbalances and instead advocate across-the-board liberalization.
Around the time, the Chinese started their SEZ initiatives in the early 1980s. India pitched in with its nascent export enclaves. Over time, six EPZs were created in places that had access to seaports. Parallelly 100 per cent ECU and similar schemes were unveiled. Over the next two decades, there was a plethora of schemes focused on export promotion. The broad strain in all these was tax and duly exemptions with limited relaxation on foreign exchange transactions.
Unlike China, that coupled liberalization in FDI with SEZ initiatives. India missed the opportunity to attract FDI when it made half-hearted attempts to promote export zones. Another stark distinction lay in the fact that the Chinese SEZ involved gigantic infrastructure creation, which attracted its own share of FDI. The China model of SEZ with complete sovereignty in governance was not thought of in India at any stage.
The years of fairly muddled and hotchpotch efforts to generate clusters of industries sharing common infrastructure, that delivered very little value in export or growth terms culminated in the policy on SEZ in 2005.
The policy had a bad start with converting six existing EPZs into SEZs. There were already languishing from years of neglect and the state of the infrastructure in these was poor. The combined export turnover from all these was less than 10-12 per cent of the country’s total exports.
It was more an act of convenience to revive the fortunes of these centres. The largest of them was not more than 10 percent the size of the smallest SEZ in China. Size and infrastructure that characterize SEZs in the rest of the world were never in the minds of the policy makers here. The only change in the SEZ scheme as compared to EPZ1 EODs is that no export obligation is mandated, though net foreign exchange earnings are a pre-requisite. The latter condition defies logic since SEZ as a concept has over time lost foreign exchange earnings as a key imperative and in the Indian context it has little value given the current moves on capital account convertibility.
Thus, an SEZ unit can cater solely to the domestic market after paying the customs duty applicable to the item at the time of clearance. The other difference between the old schemes and SEZ is die benefit of duty exemption available for construction of the zone. This was missing in the EOU/ EPZ schemes and cannot be viewed as a major benefit conferred. However, ft will be seen later in the essay how this may not benefit the industry set up in SEZ much, but is arbitraged by the real estate owner. Contemporary rationale
A pertinent question that can arise for consideration is whether the new policy on SEZ has a distinctly different
rationale or objective from the approach of the earlier policies that failed to deliver any significant advantage for the
country as compared to similar policies of the Philippines, Taiwan or Korea, not to mention China’s far superior strategy.
The Indian policy lacks a grandiose purpose either in terms of creating a completely different type of infrastructure or an industry focus that would attract significant foreign capital as in the case of other countries. The investment that is slated to find its way into the new SEZ enclaves would have come any way into the country if the existing schemes of tax holiday as applicable to export oriented units had continued. In fact, the quantum and actually that quantum of investment would have to be much more if other policy liberalizations had happened in tandem.
The support for this, rather pessimistic view is found in the fact that out of 26 7 cases cleared till September 30,2006 by the Board of Approvals, 133 cases are SEZs of less than 0.4 square miles in area and only about five are of any internationally significant size. The smaller SEZs for IT/IITES (the minimum prescribed area of 10 hectares) constitute nearly 53 per cent of the total approved cases. This exemplifies the fact that no significant large infrastructure creation is either possible or likely to arise, which has successfully been the engine of growth in the SEZ phenomenon across the globe.
The reason for such a large number of projects in the IT sector is fact that income tax benefits for this sector are expiring in March 2009 and by converting or migrating the operations that currently enjoy the tax holiday into SEZs, the industry hopes to enjoy the tax holiday for further periods allowed under the policy. This is an unfortunate and perverse development where the SEZ route is exploited by an industry that neither creates nor requires any significant infrastructure for its operations. These businesses that are currently scattered in different parts of various cities may now congregate into designated SEZs for continuing the tax benefits, adding to the pressure on urban infrastructure.
It could have never been on the wish list of the IT industry that it required continued tax subsidy for its progress, nor was the absence of tax holiday seen as a hurdle in attracting fresh investment in this. Thus the SEZ, which significantly catalyzed infrastructure and industrial investment in other countries, may end up creating dismal IT complexes and multi-storied buildings in India with the sole objective of continuing tax exemption. If the tax exemption for software technology park units gets extended, the significant number of SEZ proposals will evaporate. The only logic for the SEZ scheme could be the position adopted that it is more compatible with the WTO regime as compared to other schemes in place. This also is an unverified proposition to serve as the basis for justifying or providing the rationale for the current policy. In fact, the current scheme that provides pro rata exemption of income taxes to SEZ units based on export turnover is more likely to be viewed as a subsidy under the SCM clause of WTO and countervailed by the importing countries as it happened in the case of EPZ and EOD units.
To round off the discussion on the rationale for SEZs, it will be profitable to understand the imperatives that seem to exist in other countries that have more successfully adopted this model. One of the key reasons for setting up SEZs was the need to provide a high degree of economic freedom in an otherwise restricted regime. The compulsions could have been either in terms of high duty and tax structure applicable in that country, or limitation on free use of exchange, or freedom for foreign investments.
Another factor that has driven SEZs was the need to relax rigid labour laws, which could not be done on a national scale. It is also a fact that countries saw significant benefits in using SEZs for opening up the economy in a limited fashion to handle political oppositions while hoping that technology and skill transferred by this process would have backward linkages to the rest of the economy.
These benefits worked meaningfully in situations that existed more than a decade ago in many developing countries. The economic liberalization that has happened in recent years, voluntarily or through compulsion from agencies such as WTO or IMP, have to a large extent limited the validity of this rationale.
Even in the Indian economy that has liberalized at a slower pace when compared to many others, many of the above aspects would appear misplaced or inapplicable. The biggest benefit that countries like China saw in their SEZ policy was the creation of massive infrastructure in identified places. In India, given the average size of the approved SEZs, infrastructure creation is most unlikely to be a driving force in this process.
Land acquisition issue
Having dealt with the aspects of the need and rationale above, it is important to complete this analysis of SEZ by dealing with concerns that have surfaced, some of them taking a serious turn in the context of SEZ implementation in India. The concern that the Government itself has expressed through the Finance Ministry is on account of loss of revenue through duty concessions conferred under this. Some of the figures toted up by the Government look suspect.
As mentioned earlier in this article, the SEZ policy has only one extra concession that was missing in the earlier policies – the duty and tax exemption for the developer. This alone cannot amount to the sum mentioned in this regard. All other tax and duty concessions for the SEZ units always existed for EOD and EPZ schemes and thereby cannot be viewed as incremental revenue loss. In other words, if EOD and EPZ schemes continued to attract the same level of investment as SEZ at present has, the revenue loss cannot be viewed as arising on account of 8EZ policy.
The other concern that has taken serious dimensions is the way land acquisition for SEZs has been happening. It is a fallacy to view SEZs as a reason for exploitation of poor agricultural landowners because of land acquisition. Land acquisition for industrial use is an existing phenomenon and unfortunately the Constitution was amended to exclude the right to property as a fundamental right, sanctifying acquisition of land by the Government for any purpose. Any form of land acquisition other than for ostensible public purpose like building of a road, a bridge’ or the like should never have been allowed unless the process was carried out transparently through public bidding.
In other words, if land was required to facilitate setting up of private business, the Government should have only acted as a facilitator in a bidding process that would help bring out the real potential value that could be encashed by the land owners. The current procedure of fixing a compensation based on current use of the land (which does not recognize the converted use) is completely colonial and most unfair. SEZs may have accentuated this phenomenon; but it is nothing exclusive to that policy. It is unfortunate that the laws in this regard in a so called liberal democracy are more antagonistic to the interests of the citizens than in highly authoritarian regimes like Russia and China.
Another issue for discussion is the opportunity for real estate leverage created through the SEZ phenomenon. By virtue of the fact that SEZs are select domains for tax breaks and that the developer can claim tax and duty benefits together with an opportunity to acquire land at cheaper rates (as explained above) this policy has unfortunately become a tool for real estate gamble. The developers are seen to be seeking premium rental value for SEZ facilities when their cost of development is subsidized by the Government and is much less than non-SEZ facilities. This artificial arbitrage, enabled by tax concessions to the developer, coupled with the ability to command a premium on rent from user units, has led to the phenomenon of most SEZ projects being promoted by popular real estate players rather than by serious infrastructure agencies or organizations. Allowing SEZs of size as small as 25 acres is the cause of the above leverage.
If the SEZ policy is to provide a real economic impetus especially in the form of creation of world-class infrastructure, the minimum size should be fixed at 1,000 hectares or the minimum investment at Rs. 10,000 crore. If the right price is paid for acquiring land through open bidding land of any size may be available. Otherwise, the current phenomenon of mushrooming SEZs in and around major cities will only add to the pressure on the already weak urban infrastructure and will result in migration of people to cities when the objective should be a reversal of this trend.