SEZ Policy- Aaradhana Aggarwal

7/27/2019 SEZ Policy- Aaradhana Aggarwal

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Economic and Political Weekly November 4, 2006 4533

ARADHNA AGGARWAL

Export Processing Zones (EPZs) arean international phenomenon in-fluencing increasing share of

trade flows and employing a growingnumber of workers. In 1986, there were176 zones across 47 countries; by 2003,the number had increased to over 3,000across 116 countries.

Over the past few years, the policy ofpromoting zones has found favour withthe government of India as well. In 2000,the government replaced the old EPZregime by a new scheme of SpecialEconomic Zones (SEZs) with severallucrative incentives/benefits that were notavailable in the earlier scheme. In 2005,it enacted the SEZ Act and the SEZRules were notified in February 2006.The policy is expected to give a big pushto exports, employment and investment inSEZs. The ministry of commerce claims

that these zones are expected to attractinvestment of about Rs 1,00,000 croreincluding FDI of Rs 25,000 crore andcreate additional 5,00,000 direct jobs, byDecember 2007.

These claims notwithstanding, thepolicy has come under heavy criticism.Dissenters contend that the policywould be misused for real estate deve-lopment rather than for generatingexports. Concerns have also been ex-pressed on the displacement of farmersby land acquisition, loss of fertile agricul-

tural land, a huge revenue loss to theexchequer and adverse consequences ofuneven growth.

This article revisits the debate. Itdescribes the economic rationale forSEZs; examines Indias experience withEPZs/SEZs; discusses the context inwhich SEZ policy is being promoted inthe country; reviews the arguments forand against SEZs; analyses what wentwrong, from the perspective of thepromoters of the scheme; and finally,draws lessons.

The promotion of SEZs is an attemptto deal with infrastructural deficiencies,procedural complexities, bureaucratichassles and barriers raised by monetary,trade, fiscal, taxation, tariff and labourpolicies. These structural bottlenecksaffect the investment climate adverselyby increasing production and transactioncosts. Since country-wide development ofinfrastructure is expensive and implemen-tation of structural reforms would requiretime, due to given socio-economic andpolitical institutions, the establishmentof industrial enclaves (SEZs/EPZs) isseen as an important strategic tool forexpediting the process of industrialisationin these countries. The zones offer numer-ous benefits such as, (i) tax incentives,(ii) provision of standard factories/plotsat low rents with extended lease period,(iii) provision of infrastructure and utilities,(iv) single window clearance, (v) simplifiedprocedures, and (vi) exemptions from

various restrictions that characterise theinvestment climate in the domesticeconomy.

These benefits foster a conducivebusiness environment to attract localand foreign investment, which wouldnot otherwise have been forthcoming.The competitive advantages of zonesmay also be explained within the frame-work of the cluster approach. Zonesare industrial clusters where externaleconomies of scale and other advantageshelp the operating firms in reducing

costs, developing competitive produc-tion systems and attracting investment,in particular, FDI. As a result of thesebenefits, many developing countrieshave been promoting zones with theexpectation that they will provide theengine of growth to propel industrialisation.

There is, however, no conclusiveevidence regarding the role of the zonesin the development process of a country.The literature review indicates thatwhile some countries have been able tocapture the dynamic and static gains

from zone operations, many others havenot [Aggarwal 2006a]. In that context,it is important to analyse the Indianexperience.

Indian Experience

A micro level analysis of the zonescontribution to industrialisation efforts inIndia reveals that EPZs have had a catalyticeffect in promoting new productionsectors, exporting new products and inbuilding up the countrys image in certainproducts in international markets[Aggarwal 2006b]. The foundation of themodern jewellery industry in India, forinstance, was laid in SEEPZ in Mumbaiin 1987-88. It was there that the waxsetting technique was introduced in

jewellery production, which made massscale production possible and dramati-cally transformed the labour-intensive

jewellery industry from its cottage in-dustry status into a highly mechanisedmodern industry. SEZs accounted forover 55 per cent of total Indian jewelleryexports in 2002-03. Zones have also beeninstrumental in creating the base forthe growth of the electronics industrythrough technology transfers, spilloversand demonstration effects. Until the early1980s, electronic hardware exports wereprimarily originating from EPZs. Evenduring 2000-02, the share of SEZs in

total hardware exports was as much as26 per cent. The Indian software sagaalso really began in SEEPZ, Mumbai[Heeks 1996]. The first major breakthroughin Indias software exports came in 1977when the Tatas established a unit inSEEPZ in partnership with Burroughs,an American company, to export softwareand peripherals. A further breakthroughin the progress of the industry occurredwhen, in 1985, Citibank established a 100per cent foreign-owned, export-oriented,offshore software company in SEEPZ.

This company drew attention to thepossibilities available for offshore soft-ware development in India. Soon after,Texas Instruments and Hewlett-Packardestablished subsidiaries in Bangalore, in1986 and 1989, respectively and the restis history.

The success stories notwithstanding,the economic contribution of SEZsremained minuscule at the national level.Though India was the first Asian countryto take the free zone initiative and set upthe first zone in Kandla as early as in 1965,

Special Economic Zones:Revisiting the Policy Debate

A discussion of the pros and cons of the controversial

SEZ policy.


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the share of SEZs in exports was a mere5 per cent in 2004-05. Furthermore, theyaccounted for only 1 per cent of factorysector employment and 0.32 per cent offactory investment in the same year[Aggarwal 2006b]. Their contributionto regional economies has also been lim-ited. Although they have had a positiveimpact on regional employment andhuman development by creating economicopportunities, especially for those withouthigh levels of schooling, their potentialin contributing to human developmenthas not been fully exploited due to theirfailure in attracting investment and pro-moting economic activities in the region[Aggarwal 2006c].

SEZ Regime: Indian Context

The 1991 reforms did not result in asustainable growth in manufacturing,there was a significant slowdown in thesecond-half of the 1990s. Bureaucratic redtape, administrative procedures, rigidlabour laws and poor infrastructure arebelieved to have affected the investmentclimate adversely in the manufacturingsector [Acharya 2006]. To address theseissues, the government reverted to EPZswith the expectation that if they couldeffectively be separated from the rest ofthe economy then they could providethe engine of growth to propel the

manufacturing sector. It was argued thatthe existing zones could not succeed inattracting investment because of the lackof government commitment to theprogramme, piecemeal reforms, policyreversals, poor site selection, failure toprovide word class infrastructure, weakincentives and poor regulation of the zones.In a major initiative to boost export-ledgrowth and motivated by the success ofChinese SEZs, the government replacedthe EPZ scheme with the SEZ schemein 2000. The main difference between an

SEZ and EPZ is that the former is anintegrated township with fully developedinfrastructure whereas an EPZ is just anindustrial enclave. Under the new scheme,all existing zones were converted intoSEZs and three greenfield SEZs becameoperational by 2004. However, the impactof SEZs remained far removed fromexpectations. In order to provide a signifi-cant thrust to the policy, the governmentenactedthe SEZ Act 2005. The act becameoperative in February 2006 after theSEZ rules were framed and notified. In

addition, state governments also enactedtheir own SEZ laws, primarily to coverstate subjects. The salient features of theSEZ Act are as follows.Governance: An important feature of theAct is that it provides a comprehensiveSEZ policy framework to satisfy the re-quirements of all principal stakeholders inan SEZ the developer and operator, oc-cupant enterprise, out zone supplier andresidents. Earlier, the policy relating to theEPZs/SEZs was contained in the ForeignTrade Policy while incentives and otherfacilities offered to the SEZ developer andunits were implemented through variousnotifications and circulars issued by theconcerned ministries/departments. Thissystem did not give confidence to investorsto commit substantial funds for develop-ment of infrastructure and for settingup units.

Another major feature of the Act isthat it claims to provide expeditious andsingle window clearance mechanisms.The responsibility for promoting andensuring orderly development of SEZs isassigned to the board of approval. It is tobe constituted by the central government.While the central government may suomotu set up a zone, proposals of the state

governments and private developers are tobe screened and approved by the board.At the zone level, approval committees areconstituted to approve/reject/modifyproposals for setting up SEZ units. Inaddition, the Development Commissioner(DC) and his/her office is responsible forexercising administrative control over azone. The labour commissioners powersare also delegated to the DC. Finally, clause23 requires that designated courts will beset up by the state governments to try allsuits of a civil nature and notified offencescommitted in the SEZs. Affected partiesmay appeal to high courts against the ordersof the designated courts.

Incentives: The Act offers a highly at-tractive fiscal incentive package, whichensures (i) exemption from custom duties,central excise duties, service tax, centralsales taxes and securities transaction taxto both the developers and the units; (ii) taxholidays for 15 years (currently the unitsenjoy a seven year tax holiday), i e, 100per cent tax exemption for 5 years, 50 percent for the next five years, and 50 per centof the ploughed back export profits for thenext five years1; and (iii) 100 per centincome tax exemption for 10 years in ablock period of 15 years for SEZ developers.

Institute for Studies in Industrial Development (ISID)

New Delhi

Faculty Positions

ISID proposes to recruit Faculty seeking a career in research at the Institute, at different

levels of Professor, Associate Professor and Assistant Professor/Research

Associate. These carry UGC pay scales.

Candidates for the posts of Professor and Associate Professor should have a doctoral

degree, good academic record and research experience of ten and five years, respectively.

Minimum qualification for Assistant Professor/Research Associate is a Ph.D. Candidates

should have aptitude for undertaking empirical research in at least one of the following

areas: foreign investments, international trade, technology, IPRs, capital markets, public

enterprises, SMEs, industrial location, entrepreneurship, corporate affairs, competitionlaw, regulations and employment.

Candidates may kindly send their resume stating qualifications, experience and publications

along with names of two referees. Copies of the publications need not be sent. Last

date for receiving the responses at the institute is November 20, 2006.

All communications to:

The Director, Institute for Studies in Industrial Development, 4 Institutional Area,

Vasant Kunj, P.B. No. 7513, New Delhi 110 070. Phone: 011-26891111.

email: [email protected] [email protected].


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Table 1: Current Status of Upcoming SEZs

SEZ Status Investment Employment (No)

Nokia, Tamil Nadu: Commenced commercial US$ 100 Million Direct : 2800

production Indirect : 10000

Quark City, Chandigarh: Inaugurated $ 0.5 billion FDI* 35000* by May 2007

Flextronix in Tamil Nadu C ommen ces op eration $100 million 3000* (2500 under

in November 2006 training)

Motorola and Foxconn, Units being set up $200 million* 5000* by December 2007

Tamil Nadu

Apache SEZ (Adidas Construction started $50 million* 25,000*

Group), Andhra PradeshDivvys Labs, Commenced operations NA 8000* by April 2007

Andhra Pradesh

Rajiv Gandhi Technology Construction started NA 5000* by June 2007

Park, Chandigarh (500 under training)

Brandix Apparel SEZ, Construction started $100 million* 26000* by March 2007

Andhra Pradesh

*Expected.

Infrastructure: Provisions have beenmade for (i) the establishment of freetrade and warehousing zones to createworld class trade-related infrastructureto facilitate import and export of goodsaimed at making India a global tradinghub; (ii) the setting up of offshore bank-ing units and units in an internationalfinancial service centre in SEZs; and(iii) the public private participation ininfrastructure development; and (iv) thesetting up of a SEZ authority in eachcentral government SEZ for developingnew infrastructure and strengthening theexisting one.

There has been a tremendous rush toset up SEZs since the Act came into effectin February 2006. The total number ofapprovals and in-principle approvals across21 states as on October 27, 2006, was 212and 152, respectively. As on date, 34 SEZsout of these approvals have been notified.Table 1 shows the current status of theupcoming SEZs.

The Debate

The SEZ policy has become one ofthe most hotly debated issues in recentyears. Huge protests are being organisedby those who stand to lose their land.There has been a scathing campaignagainst SEZs by politicians, scholars,media and civil society. Of much more

concern however is the fact that thereare differences within the governmenttoo. The Congress president SoniaGandhi has also expressed her reserva-tions over the impact of SEZ policy ondisplaced farmers and the Reserve Bankof India has asked the banks to treatSEZ lending as real estate businessand not infrastructure. The advocatesof the policy led by the ministry ofcommerce have however strongly de-fended the policy. Table 2 summarisessome of the major concerns and counter

arguments.Though the ministry of commerce hasattempted to dispel the criticism of the SEZpolicy, the fact remains that the SEZ Actwas framed without giving adequatethought to most of the ancilliary issues.No exercise was undertaken to ensurethat legal institutions are in place formassive land acquisition. No long-termstrategy was drawn to counter the socio-economic consequences of the scheme.Even amid heavy criticism of the policy,no serious research has been conducted

Table 2: Arguments For and Against SEZs

Issue Argument against SEZs Counter Arguments for SEZs

Reloca tion Companies wil l simply relocate to SEZs Special provi sions have been made

to take advantage of the tax concessions in the act under which tax exemptions

being offered and little net activity will are applicable only if the unit is not

be generated. formed by splitting up, or the

reconstruction, of a business already

in existence and it is not formed by

the transfer to a new business of

machinery or plant previously used

for any purpose. Relocation of units to SEZs would

involve cost and loss of efficiency.

There is little incentive to relocate

due to the continuation of various

export promotion schemes such as

the duty drawback scheme for

outside units and other business

practices prevalent outside the zones.

Revenue loss The policy would cause a revenue loss Revenue loss is not ional as wi thout

of Rs 9,39,000 million over the next the SEZ Act, there would not be much

four years. If an annual average of this investment in the zones.four-year figure is drawn, it comes out SEZs would bring a net revenue gain

to be Rs 23,475 million, which is about of Rs 4,40,000 million on account of

6.7 per cent of the central governments additional investment activities.

total revenue receipts during 2005-06.

Land acquisit ion The act wil l lead to a large-scale land The land requirement of al l SEZs

acquisition by developers, displacement (including those under consideration)

of farmers, meagre compensation and is 1,00,000 hectare, which is lessno alternative livelihood for them. than 0.1 per cent of total cult ivable

land in India.

The total land area in 212 formal

approvals granted till date is 33,761

hectares out of which 50 approvals

are for state industrial development

corporations/state government

ventures, which account for 17,800

hectares approximately. No fresh

land acquisition took place for any ofthese cases.

Different states have their own land

acquisition laws. Some states also

have special land acquisition laws

for SEZs. The onus is on state

governments to put in place

reasonable and transparent land

acquisition laws for SEZs and

implement them effectively.

SEZ developers are required to

provide for an adequate relief and

rehabilitation package for the

affected.

(Contd)


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In Maharashtra, MIDC has come out

with a R&R package which includes

assured employment for members

of the displaced families and land at

concessional rates for them in the

developed area.

Loss of agricultural SEZ will be built on prime agricultural The general consensus in the board

land land with serious implication for of approval and state governments

food security. is that mainly waste and barren landand, if necessary, single crop

agricultural land alone should be

acquired for the SEZs. If perforce a

portion of double cropped

agricultural land has to be acquired

to meet the minimum area

requirements, the same should not

exceed 10 per cent of the total land

required for the SEZs.

Misuse of land Promoters will get land cheaply and will To regulate usage of the SEZ area

for rea l es tate make their fortune out of real estate by the developers, the SEZ board of

development and speculation approvals will assess the size

indiscriminately. The minimum required requirement of infrastructural facilities

processing area is 35 per cent. The rest like housing, commercial spaces,

will be for residential, recreational facilities. recreational amenities, etc, based on

the employment generation potentialof the SEZ. In the first phase it is

proposed to allow only a maximum

of 25 per cent of the approved

housing while the other approved

infrastructure will be allowed to be

created as per the developers plans

and as approved in the Master Plan.

The balance housing shall be

allowed to be established by the

approval committee in three phases

depending upon the progress in

allotment/occupancy of units in the

processing area.

Uneven growth There is a strong possibi li ty that SEZs Almost every state wil l have SEZs

will be set up in states where there is under the policy. This will promote

already a strong tradition of infrastructure development andmanufacturing and exports. This will industrialisation in states such as

aggravate regional disparities. UP, Orissa, West Bengal

The trend is already seen in the initial

approvals. The share of the four most

industrialised states (TN, Karnataka,

Gujarat and Maharashtra) in total

approvals is 49.5 per cent. Andhra

Pradesh, Kerala and Haryana account

for another 31.1 per cent of total

approvals. Thus seven states account

for 80.6 per cent of approvals. Their

share of in-principle approvals is

63.8 per cent. On the other hand,

industrially backward states of Bihar,

north-east and J and K do not have a

single approval.

I ne qu it ie s The incentives dished out to SEZs will EOUs have the freedom of setting

create a tilted playing field between up their businesses anywhere in the

SEZ and non-SEZ investors. country and are enjoying the benefit

of DTA sales, which is not available

to zone units.

on how SEZs will affect the regionaleconomy, how much fertile land willactually be lost, how many farmers willbe affected and what the tax implicationsof SEZs will be. Most arguments are basedon the perception of officials. There istherefore an urgent need to institute a study

(61 per cent) has been in the IT sector.The manufacturing sector accounts foronly one-third of total approvals. Thispattern is worrisome. In view of thedeclining competitiveness of the manu-facturing sector, the focus of the SEZpolicy needs to be on making India apreferred destination for manufacturing.It is however encouraging to note that theshare of manufacturing SEZs in approvals-in-principle is 69 per cent.

Furthermore, it is instructive to note thatSEZs do not embody dynamic forces thatcan point towards sustainable development.In the long run the competitiveness ofSEZs can be sustained only if economy-wide investment climate is improved. Thisis because zones cannot be insulatedfrom the broader institutional and eco-nomic context of the country. The key tosuccessful industrialisation in the long runthus lies in shaping the existing institutionssuch that they drive firms towards anoutward orientation and technologicalupgradation; the creation of zoneswhich offer the easy option of competingon the basis of cost minimisation shouldonly be treated as a transitory policy arrange-ment. Zones should not be considered thebest policy option for long-run industrialdevelopment. Thus, the establishmentof EPZs should not be regarded as asubstitute for pursuing institutional andinfrastructural improvements.

Email: [email protected]

Note

1 This is applicable to SEZ units who begin theiroperations during the previous year relevantto any assessment year commencing on or afterApril 1, 2006.

References

Acharya, S (2006): Essays on MacroeconomicPolicy and Growth in India, Oxford University

Press, India.Aggarwal, A (2006a): Performance of Export

Processing Zones: A Comparative Analysis ofIndia, Sri Lanka and Bangladesh,Journal ofFlagstaff Institute, 30(1), World EPZAssociation, Arizona, US.

(2006b): EPZs and Productive Diversification:A Case Study of India, ongoing study fundedby the World Bank.

(2006c): Impact of Export Processing Zones onEmployment, Human Development andPoverty in India, UNDP Working paper(forthcoming).

Heeks, R (1996):Indias Software Industry, SagePublications.

on the socio-economic effects of SEZsunder consideration.

A Note of Caution

The sectoral break of SEZ approvalsshows that the largest number of approvals

Table 2: Arguments For and Against SEZs (Contd)

Issue Argument against SEZs Counter Arguments for SEZs

EPW

Documents

SEZ Policy- Aaradhana Aggarwal