ABC of SEZ

The controversies surrounding the special economic zones refuse to go, as the land acquisition and rehabilitation issues continue to haunt. Government has now decided to put on hold clearances for new SEZs until new a rehabilitation policy is in place. A Times of India editorial on the subject (Jan 20, 2007).

The Centre has been forced to put on hold clearances for new special economic zones (SEZs). The SEZ policy has attracted controversy since it was first announced in 2005. The government's reason for the present pause is that it would wait for the national rehabilitation policy to be in place before allowing new SEZs. On the face of it, it is a sensible decision since large tracts of land are expected to be acquired by the government for SEZs. This is bound to force thousands of people out of their homes and present livelihoods. In the absence of a proper rehabilitation policy, resettlement of SEZ oustees would become a tardy affair. Already, the government is facing the heat in places where land has been acquired.

The opposition to SEZs is taking the shape of a loose coalition of disparate outfits ranging from grass-roots activists, including Medha Patkar and former prime minister V P Singh, to NGOs and even Left extremists. Sections of the political mainstream, including those within the Congress, are worried about the SEZ policy. The groundswell against land acquisition has been exploited by opposition parties at the local level to target the party in office. It is obvious that the Centre would not like the SEZ policy to become a magnet for opposition parties prior to assembly elections in Punjab and Uttarakhand, which have Congress governments.

That some of the vocal opponents of the SEZ policy have been valuable allies of the UPA during the 2004 elections would add to Congress's discomfort. The trouble over the SEZ policy is another indication of the flawed nature of Indian democracy. Policies are announced by the government without carefully studying their implications. In the case of the SEZ policy, the government should have worked out a consensus with all the political parties and civil society organisations. A top-down approach to development is fraught with the danger of alienating the state from even the intended beneficiaries. It is not too late to change. In the case of projects that are land-intensive, a dialogue with people who reside and live off that land is essential. The government needs to look at them as stakeholders in the project and treat them as venture capitalists, their capital being land. Fears of home and livelihood loss have to be addressed at various levels if the necessary, and inevitable, industrialisation of the Indian economy has to happen. Before setting out to implement the SEZ policy, the government should have followed the ABC of governance; it ought to have gained the trust of the people.

THE ABC OF SEZ
What is Special about SEZs, China's experience, the Indian experiment, the politics and the economics ...

A Special Economic Zone (SEZ) is a geographical region where economic laws are more liberal than a country's typical economic laws. SEZs are set up with a view to increasing investments – typically foreign investments - and promoting exports, by offering privileged trading terms. Usually an SEZ is designated as a duty free enclave and treated as foreign territory for the purpose of trade operations, duties and tariffs.

SEZs have been established in many countries like China, India, Philippines, Russia, Iran, Jordan, Poland, Kazakhstan and North Korea at varying scales and with varying degrees of success. In India, the government’s big bang approach to push through a large number of SEZs has generated lot of heat and triggered a nation-wide debate on the costs and benefits of SEZs, including the issues like social displacement caused by large-scale conversion of agricultural hinterland into industrial belts.

International experience with SEZs has shown that by offering various incentives, SEZs can attract investment and foreign exchange on a large-scale, generate employment and boost infrastructure and technological development. However, critics claim that SEZs attract investments only by offering distortionary incentives rather than building underlying competitive conditions. These incentives create a fiscal burden on the taxpayer and hurt environmental and labor standards. In addition, critics argue that the direct and indirect costs of maintaining zone privileges do not benefit the rest of the economy and, instead, lead to “out-of-bound” enclaves of prosperity. It has been widely recognized that promotion of SEZs in the context of an overall strategy to promote economic development, active linkage programs and adequate social and environmental safeguards are necessary to reap the maximum benefits from SEZs at the minimum cost to the society.

China's Experience
The Chinese model of SEZs has been very successful and SEZs there have been considered as remarkable contributors to the miraculous economic growth of the country. The dragon’s success story has inspired many other countries, including the other Asian giant India, in their pursuit of foreign investment and export-led growth. A brief on how China did it.

China started the SEZ experiment as early as 1980s as part of the broader economic reforms and opening-up policy. The first group of SEZs was set up in Shenzhen, Zhuhai & Shantou in Guangdong province and Xiamen in Fujian province - all located in costal areas of Southeast China. This was followed by other 10 costal cities, Hainan Province and Pudong area in Shanghai. To further build on the success of these SEZs, China went on to establish “Economic and Technological Development Zones” (ETDZ) on similar lines. Compared to SEZs which were developed in the whole city (sometimes whole province), ETDZs are developed on relatively small geographical areas earmarked in coastal and other open cities. The overall development of SEZs in China has moved along the following 3 dimensions: extending from SEZs to ETDZs; stretching from east costal region to inland middle and west region; upgrading from fundamental industries to hi-tech industries..

The Indian Experiment
Government of India embarked on the path of economic liberalisation way back in 1991, with foreign investment as one of the foundations of economic policy. However, it was only in 2000 that a policy on SEZs was formulated.

The objective of the policy is to facilitate setting up of SEZs, with a view to providing an internationally competitive and hassle free environment for exports. The policy provides for setting up of SEZs in the public, private or joint sector and envisages a lead role for the state governments, in line with the general trend of decentralization in governance and policy implementation. SEZ units may be for manufacturing, trading or service activities.

The SEZs are designated as a “duty free enclave” and will be treated as foreign territory for trade operations and duties and tariffs. The privileges include no license requirement for imports, exemption from customs duty on import of capital goods, raw materials, consumables, spares, etc., exemption from central excise duty on procurement of capital goods, raw materials, consumables, spares, etc. from the domestic market, reimbursement of central sales tax paid on domestic purchases, 100% income tax exemption for a block of five years, 50% tax exemptions for two years and upto 50% of the profits ploughed back for next 3 years, and 100% foreign direct investment allowed in manufacturing sector through automatic route barring a few sectors.

SEZs currently operating in India are located at Kandla and Surat in Gujarat, Cochin in Kerala, Santa Cruz (Mumbai) in Maharashtra, Falta and Manikanchan - Salt Lake in West Bengal, Chennai in Tamil Nadu, Visakhapatnam in Andhra Pradesh, Noida in Uttar Pradesh, Indore in Madhya Pradesh, and Jaipur in Rajasthan. In addition, numerous SEZs are at various stages on development in various parts of the country.

The current debate on the potential revenue loss, the accusations of “land grab” by real estate operators in connivance with politicians and middlemen and the sharp political divides on the issue (there are differences even within the government) are likely to slow down the development of SEZs in the near term. This may actually be an occasion to look at the issues afresh and tighten the policies so as to harmonise the whole process with the broad goals of economic development.

Who is afraid of SEZs?

It’s not just Sonia Gandhi who is worried about the development of Special Economic Zones (SEZs) in India and its immediate political fallout. The debate on SEZs is getting hotter and hotter with criticism coming in from various quarters, including the Finance Ministry and the Reserve Bank of India. Even Prime Minister Manmohan Singh recently asked the states, without mentioning SEZs, to go slow on offering sops to drive industrial development. “The jury is still out on whether these policies (incentives) really promote industrial growth” said the Prime Minister.

The ever-growing list of powerful people questioning the way SEZs are conceived and being developed in the country has turned the focus on the whole range of issues from the long-term social and economic consequences to revenue implications, uneven development and sacrifice of prime agricultural land to boost industrial growth. Although SEZs are expected to boost investments, industrialization and exports in a big way, the costs and benefits need to be weighed carefully.

Finance Minister has expressed concerns over the loss of tax revenue due to the sops offered to the SEZs. RBI has also cautioned the government on potential revenue loss saying that the incentives may be justified only if the SEZ units ensure forward & backward linkages with domestic economy – and this is a big ‘if’. Acting on its view, RBI has already announced guidelines to banks that will make it difficult for them to lend to the SEZs in a big way. Financing of SEZs will be treated like commercial real estate lending, attracting higher risk weight for the purpose of capital adequacy. This means banks will have to set aside a larger capital for such lendings as compared to other assets.

Another worry is that the mushrooming of SEZs would aggravate the widening inequality in India - both in terms of individual income levels and national infrastructure. The IMF Chief Economist Raghuram Rajan has warned: “Not only will [the SEZs] ... make the government forgo revenue it can ill afford to lose, they also offer firms an incentive to shift existing production to the new zones at substantial cost to society.” Given the way large corporates are rushing to grab the 'sweetheart' deals offered by the state governments, the ‘land grab’ in the name of SEZs is going to badly affect the livelihood of a large number of farmers. Swathes of prime agricultural lands will be converted into ‘islands of prosperity’ and the affected farmers will definitely not be in a position to transition to the jobs created in these ‘islands'.

The issue of “land grab” has turned out to be the most controversial aspect of the SEZs, also politically the most sensitive one and perhaps the last straw on the proverbial camel’s back. This is the issue that has caused sharp political divides and forced a re-look at the entire gamut of the planning and development of SEZs. The international experience with SEZs has shown that only large SEZs are likely to succeed and that for every successful SEZ ('Shenzen’ is the name that comes to mind immediately) there are numerous failures. Clearer guidelines are needed for land acquisition and compensation to farmers. The possibility of using barren and wasteland - of which we have plenty - for setting up of SEZs, rather than fertile agricultural land, should be explored.