Fading SEZ appeal

India needs to get the basics right

The government has started work on replacing the Special Economic Zones (SEZ) Act, 2005, with a new law. The finance minister has indicated that the updated legislation would enable states to become “partners in the development of enterprise and service hubs”. The sustained enthusiasm for SEZs is hard to understand, given their serial underperformance. These failures could, however, offer useful lessons for the government. India was among the first Asian countries to experiment with the concept in the 1960s, which resulted in a series of export-processing zones and export-oriented units, which did not yield the expected boost in exports. But with China’s economic miracle built on its free trade zones, the United Progressive Alliance government decided to emulate India’s northern neighbour by passing a law designed to incentivise private investment in industrial infrastructure. SEZ developers and firms within them were given a raft of tax exemptions — exim duties, excise, and a 15-year tax holiday on profits. This apart, SEZ developers were allowed to create de facto private townships within these zones. Even these substantial benefits did not transform SEZs into engines of economic growth. The commerce ministry data shows that exports from SEZs have rarely crossed 20 per cent in the past five years.
 

The weaknesses of the policy were evident from the get-go. First, unlike China, the SEZ policy’s reliance on the private sector created several problems. Tax breaks for township development made SEZs a huge real estate play and, indeed, the bulk of the initial SEZ applications came from realtors. Second, in place of the gargantuan SEZs that came up under state auspices in China, allowing for massive economies of scale that yielded the famous “China price”, the Indian law allowed for seven types of zones — such as for multi-product or a single sector. The upshot was that most SEZs were small — between 100 and 200 hectares and many as little as 10 hectares — hardly conducive to price competitiveness on the China scale. This apart, 70 per cent of the SEZs were in the IT and ITeS sectors, which was already a racehorse and did not require extra benefits. The share of job-creating manufacturing, the original purpose of the policy, has been consistently low because the old problems of transport and other linkages persisted.

The biggest hurdle to the SEZ policy came from the lack of popular acceptance because of serious flaws in land acquisition practices. Proposals for big single-product zones requiring, say, over 1,000 hectares regularly came up against opposition from farmers unwilling to sacrifice settled livelihoods for uncertain and sometimes sub-par compensation. Protests affected both private sector attempts to acquire land and state governments’ efforts to acquire it on their behalf, the latter practice proscribed in a subsequent land acquisition law. Finally, the bane of Indian business, policy instability in the form of a gradual withdrawal of tax breaks, sharply reduced the attractiveness of SEZs, illustrated by the fact that 101 applied for denotification between 2008 and 2020. The government has hinted that the new law may allow SEZ units to sell in domestic tariff areas and accept rupee payments, which dilutes the concept in any case. But the real lesson is that creating investment havens can work only if the whole country is geared to that end.