Aradhna Aggarwal & Rajiv Kumar: De-mystifying SEZs

Critics blindly accept the tax loss estimates while ignoring the welfare gains

In a recent interview, the finance minister has clarified that he is not opposed to the special economic zones (SEZ) though he does not support their proliferation. We would like to contribute to this emerging policy convergence. The total area covered under 366 formally approved SEZs in India is only 490 sq. km. In- principle approved SEZs cover an additional 1,571 square km. This is no more than 0.12 per cent of agricultural land in the country. Far more arable land is left uncultivated than this paltry acreage given for SEZs. And nearly 50 per cent of the land allocated to SEZs was previously acquired by state governments for public sector industrial zones etc that never took off. So it is really unfortunate that the land issue has been so overly politicised.

China has six SEZs spread over more than 40,000 square km area, compared with 2,000 sq kms in India. Large SEZs on the Chinese pattern may not be suited to our conditions because India does not have vast tracts of contiguous land located close to ports. In addition to six SEZs, China has set up another 187 export zones under various names. Of these 23 are in the private sector. In addition, there are 6,600 provincial and municipal level zones. All these zones enjoy tax benefits. Thus, contrary to popular perception, China has both more zones and larger ones!

The finance ministry initially put the loss of tax revenue at Rs. 93,000 crore and later revised it further upwards to Rs.102,621 crore for the four year period 2006-07 to 2009-2010. Critics of SEZs happily quote this figure without recognising that this estimate includes loss from indirect taxes, which are not supposed to be exported under any fiscal regime. But even the estimate for direct tax revenue foregone is placed at Rs 54,000 crore. The total tax revenue actually forgone on account of direct tax concession to all STPI and SEZ units in the year 2006-07 turned out to be mere Rs. 9,938 crores. This puts a huge question mark over the validity of the projections of revenue foregone on account of new SEZs.

Furthermore, revenue loss is not the same as overall welfare loss. A recent ICRIER report brings out clearly that overall welfare gains from new SEZs are not only positive but are significantly large. The Report's findings have been criticised by Sunil Jain (SJ) in his column in this paper (Business Standard, September 3) . It is most intriguing that SJ does not question the basis of the revenue loss estimated by MoF, patently exaggerated as they are, understandable perhaps in light of SJ's manifest subjective bias against SEZs.

SJ takes umbrage at two assumptions made in the ICRIER report about the level of ICOR and profit margins both of which he finds to be too low. SJ himself states that the 10th Plan assumes an economy-wide ICOR of 3.58. Given that SEZs cover a wide spectrum of economic activities including trading and services, is it not appropriate to use the economy-wide ICOR? The Report uses an ICOR of 3.5 but SJ compares this to ICORs of 8.33 for communications and 14.56 for railways. Thus, SJ compares the ICOR of labour-intensive export oriented units, which are located in the SEZs with that of highly capital-intensive sectors including infrastructure! On profit margins, we wish SJ would read reports less hurriedly. Because then he would have seen that a weighted average profit margin of 16 per cent and not 6 per cent as quoted by him is used to estimate direct tax liability. Can profit margins be higher than 16 per cent in fiercely competitive international markets?

Moreover, it is indeed unfortunate that SJ chose to focus only on numbers, because the Report categorically argues that the justification for SEZs derives from both quantifiable and qualitative benefits that they generate. Even if we assume zero net benefit on account of export activities, infrastructure investment of Rs 11,2468 crore over the next three years will itself contribute significantly to the policy objective of developing infrastructure through PPP.

The argument that SEZs have primarily attracted local investors is bogus. A large number of foreign giants: Nokia, Flextronics, Samsung , Foxxcon, ST Microelectronics, Motorola, Ericsson, Apache and Brandix, that had shied away from India until recently, have either set up or are in the process of setting up their units in SEZs. Several local investors, planning to move investments off-shore are now investing in these SEZs. According to the Ministry of Commerce, new SEZs have created formal sector employment of over 51,000 people already and significant technology transfer and skill formation. This is significant at a time when NSS data shows near stagnation in formal sector employment and it took almost 4 years from 2000 to 2004, to add 4,000 jobs in old style SEZs. SEZs attract investors because they effectively address the critical constraint of uncertain supply of necessary utilities and infrastructure facilities that characterises the rest of the economy. Of course this is a second best solution but wold SJ and his ilk prefer the perfect to become the enemy of the good? And arguing that SEZs are not needed because others are investing larger sums anyway is akin to arguing that labour reforms are not needed because firms are employing labour even in existing conditions. Marginal improvements also generate additionalities.

Finally, the SEZ policy has a positive signaling effect for both domestic and foreign investors. It has galvanised bureaucratic machinery in the states. The demonstration effects of SEZs could kick-start the process of economy-wide improvements in business climate and infrastructure for manufacturing. They should thus be given a fair chance.

The authors are external consultant and Director ICRIER, respectively. The views expressed here are strictly personal and do not represent the views of the organisations to which authors are affiliated.