What ails India's Special Economic Zones (SEZs)?

In April 2000, India introduced the Special Economic Zones (SEZ) Policy to attract investments and promote exports. In 2005, the SEZ Act was passed to emphasise the government’s commitment to a stable SEZ regime and to fulfill a range of objectives, including the promotion of exports, investments, employment, and the development of infrastructure facilities.

Fiscal concessions, in the form of tax and duty benefits as well as administrative and procedural facilitation measures were provided under the SEZ Act, along with provisions for state governments to allow exemptions from state taxes, levies and duties.

Serious reassesment

Today, a little over ten10 years since the SEZ Act was notified in February 2006, a critical assessment of our SEZ policy framework and performance is needed. A quick glance at the figures for SEZ investment, employment and exports shows that notwithstanding some years of decline, the general trend has been upward. Total cumulative investment in the SEZs increased from Rs 4,036 crore in February 2006 to Rs 2.97 lakh crore in fiscal year (FY) 2013.

Employment grew fourfold from three lakh people in FY 2008 to around 12 lakh people in FY 2014. The SEZ exports have risen from Rs 34,787 crore to Rs 4,76,159 crore between 2006-07 and 2012-13, from 6% to over 20% of India’s exports.

A closer look, however, yields a mixed picture. The fillip that the SEZs were supposed to give to Indian manufacturing has not materialised as the majority of the SEZs are in the IT/ITeS sector. There has been a considerable shortfall in actual investment, exports and employment from projected numbers.

According to a CAG survey of 152 SEZs, non-performance in employment targets ranged from 65% to 96%, from 24% to 75% for investments and from 46% to 93% for exports. There is also a large and persistent gap between the number of notified and operational SEZs. While 491 SEZs were formally approved between February 2006 and December 2014, of which 352 were notified and 33 were given in-principle approvals, only 196 SEZs were operational.

As of March 3, 2016, only 204 SEZs were functional. The gap between approvals and notifications is around 40%, and between notified and operational SEZs is over 60%. These large discrepancies indicate the long gestation periods involved in establishing the SEZs and  lack of proper viability assessment when approving the SEZs.

What explains this non-realisation of targets and failure to operationalise the SEZs? Some proximate factors include the global recession, weakening of global demand, and slowdown of the domestic economy which caused the de-notification of several SEZs. But there are several important institutional and policy factors that have contributed.

Flawed model

A major constraint has been the SEZ model adopted by India. Unlike the Chinese approach of creating a limited number of large, self-sustainable SEZs near ports with complementary infrastructure, power, and roads, the Indian model involves licensing a large number of SEZs without providing the requisite supporting infrastructure. The government here has left the development of the SEZs to private parties, creating conflicts of interest between private and public returns.

This has resulted in underinvestment in infrastructure, with consequent effects on operating costs and performance. The SEZ model is narrowly focused on fiscal incentives as opposed to facilitating business by providing infrastructure, logistics, skilling and customs support.

Subsidised provision of these soft and hard inputs by the government and adoption of trade facilitation measures, within the larger context of improving the ease of doing business would be much more conducive to operationalising the SEZs and also compatible with international obligations.

Inconsistent policy

A second factor that has hurt investment in the SEZs is lack of policy predictability, in particular of the tax regime. In 2011-12, the government retrospectively withdrew the MAT exemption for the SEZ units and developers as well as the DDT exemption, imposing a MAT of 18.5% and DDT of 15%. Although such exemptions may have been actionable under the WTO, their withdrawal has dampened investor sentiment by hurting the predictability of the tax regime facing the SEZs.

There has also been a shift towards investment-linked as opposed to profit-linked incentives under the Direct Tax Code, raising concerns about the stability of the government’s tax policies concerning the SEZs. An ICRIER study found that the retrospective introduction of MAT and lack of clarity in fiscal incentives have adversely affected export performance and investments in the SEZs.

Land acquisitions

A third important constraint is land acquisition. Delays in acquiring land, problems in getting contiguous tracts of land, delays in transfer of land, difficulties with titles and registration, delays in environmental clearances, lack of clarity on compensation and resettlement issues, and changes in land policies have been cited as major reasons for de-notification of SEZs. As the government does not have sufficient land in its possession to allot to the SEZ developers, absence of a clear policy framework to address land acquisition is a major drawback to operationalising SEZs.

Finally, investments in SEZs have been adversely affected by the provision of incentives to exporters outside the SEZs under the duty drawback, focus market and focus product schemes. These incentives have reduced the attractiveness of locating within the SEZs.

Further, the reduction or elimination of import duties under a growing number of FTAs signed by India in recent years has undermined the advantage that the SEZs enjoyed earlier, in terms of access to duty-free imports of inputs. Restriction on duty-free sale of the SEZ products within the country has put the SEZs at a further disadvantage vis-à-vis producers outside the SEZs when global demand conditions are weak.

In sum, India’s SEZs have not yielded the desired dividends for a variety of reasons. The current policy framework and approach is inadequate and piecemeal. The government needs to take a more holistic approach, while providing a predictable policy environment and requisite infrastructural and institutional support.

 (The author is professor of Economics at IIM Bangalore)