Special Economic Zones Will Indias experiment succeed?

? The remarkable difference in export performance of China vis--vis India over the last two decades has compelled India to look at its northern neighbour for successful strategies. One of the key strategies leading to the Chinese success was setting up of Special Economic Zones (SEZs) since 1980. SEZs became the drivers of Chinas massive export surge and today, the 5 major Chinese SEZs account for a cumulative FDI of approx. $70 Billion, generate 20% of Chinas total exports and provide direct employment to over 8 Million people. Indias first tryst with Export Processing Zones (EPZ) was in form of Kandla EPZ in 1965 and then subsequently Santa Cruz (SEEPZ) in 1976, much before the advent of SEZs in China. However, Indias EPZs never really took off in the face of an unclear policy, poor infrastructure and inadequate incentives to attract investment. In 2000, the Indian Government finally announced a SEZ policy based on Chinas model. The eight existing EPZs were converted into SEZs, a slew of tax incentives were extended and relaxations on the applicability of various restrictive laws were granted to these SEZs. Importantly, a clear cut policy framework for SEZs was laid down, private investment was invited for setting up of SEZs and states were encouraged to enact legislation to encourage the creation of SEZs. Since 2000, the Government and the RBI have focused on strengthening the policy framework with several policy announcements being made in the interim years. Various states have also come up with state level SEZ Acts and notifications. Although the incentives provided by the government have led to the formation of 14 functional SEZs with an additional currently under implementation, the take-off has not been as smooth as expected. SEZ Investments have been low, a number of teething issues have cropped up and the export performance has been lacklustre. Investors have complained that although the SEZ reforms were a move in the right direction, they were half hearted, wherein several important issues were left unaddressed. There was renewed hope for the languishing SEZs when the Finance Minister announced in his budget speech that the current Government also viewed SEZs as significant growth engines for boosting exports and that that it would be introducing the SEZ Bill in Parliament shortly. The minister went on to express his confidence in the fact that the passing of the law would be a significant milestone in the countrys quest to emerge as a major hub for exports. The introduction of the bill will be a much needed measure to increase the confidence of the investors. With the passage of the bill, it would become the central legislation, hence governing the income tax, customs and excise laws for SEZs and any concessions granted therein cannot be altered without the approval of the Cabinet and Parliament. A reading of the provisions of the draft SEZ bill put up by the Ministry of Commerce also gives cause for optimism. The proposed bill provides for setting up special courts and a separate enforcement agency to check economic offences in SEZs. This shall hopefully allay the fears of the foreign investors regarding Indias chronically slow and unwieldy judicial system. The bill provides for exemption from certain provisions of the Stamp Act and would also permit international insurance companies to offer insurance in the SEZs. Offshore Banking Units (OBUs) would be encouraged with a full tax exemption for five years and 50% exemption thereafter. The applicable rate of tax for OBUs has also been fixed as 5%. Though, these measures are indeed heartening, there are certain key issues that need to be addressed by the government to make the SEZs successful. An important issue has been the failure of the government to address the critical issue of labour reforms. The plethora of labour laws facing an investor wanting to set up a manufacturing facility in India is indeed daunting. A

step has been made by several states with the setting up single point clearances system and providing for minimum inspections requirement, along with delegating powers of the Labour commissioner to the Development Commissioner of each SEZ. However, on the crucial issue of laws relating to retrenchment of labour there has been no development. In fact, the World Economic Forums latest global competitiveness report ranks India 96th out of 102 countries on hiring and firing policies. The current government depends on the Communists for support hence any major labor reforms seem unlikely. However with the increasing unemployment in the country, it may be a good idea to use the SEZs as laboratories to gauge the impact of change in labour laws, and if proved successful, it could herald the way for the rest of the country. Past experience with EPZs have shown that fiscal incentives alone are not sufficient and adequate infrastructure facilities play a very critical role. Although, much is being made of the inadequate infrastructure in the country, the efforts towards addressing the issues are grossly inadequate. The loss in terms of export competitiveness is directly visible in most areas, for e.g. freight payments as a percentage of total import value is 11% for India as compared with a global average of 6%. Apart from higher costs, the inefficiency of port infrastructure also results in a higher lead-time, e.g. lead time for Indias trade with the US is 6-12 weeks in comparison to Chinas 2-3 weeks. In addition to the overall infrastructure disadvantage, the infrastructure in the SEZs currently under development also appears inadequate. In comparison to Chinas SEZs which are spread across over huge land area with a small SEZ such as Pudong being spread over 130,000 acres, the largest Indian Greenfield SEZ project is spread across an area of 7,500 acres. On the investment front, India is investing approx. $1.5 Billion, which in comparison to China is approx th 1/10 of Chinas investment in its smallest SEZ, needless to add, these levels of investment are grossly insufficient to create a world class infrastructure. One of the critical action points for the government would be to ease and fasten the process of land acquisition for the SEZs by framing adequate legislation in this regard. Also considering the heavy investments required, a large government backing for the development of the new SEZs might prove to be useful in creating world class infrastructure. In the context of more than 800 EPZs across the World, it is even more imperative for the Indian SEZs to be positioned & focused appropriately. A possible solution would be to build a have a hub-spoke mechanism for SEZs, wherein large hub SEZs, with large investments are developed with good port facilities and transport linkages catering to industries requiring heavy infrastructure, whereas other smaller SEZs requiring lower investment are created along the hinterland on basis of location advantage & economies of scale are linked to these large industry specialized SEZs. One of the major reasons attributable to the success of Chinese SEZs was their smart targeting of the industrialized markets of Hong-Kong, Macau and Taiwan. Offering a value proposition derived from lower costs ensured huge amounts of investment from these markets. Without a well defined value proposition achieved through focused targeting, it appears highly unlikely that the Indian SEZs could emulate the explosive growth of their Chinese counterparts. At the moment, the government seems to be headed for the correct path and indeed the SEZ Act will be a milestone in this process. However, if the will and resolve for tough measures and crucially the speed of these reforms are found lacking, Indias SEZs may end-up the same fate of its EPZs.

Links / Information on Special Economic Zones (SEZs) a) World Outlook Presentation by Kishore Rao, Bearing Point Inc. on April 29, 2004 in the IFC/FIAS conference, describing different types of trade zones and shares the global experience on SEZs and the best practices that have evolved. The presentation is available in the knowledge base section. b) Financing SEZs in China Presentation by Dr. Jingjing Xu, Managing Partner, GFC-China Holdings on April 29, 2004 in the IFC/FIAS conference. Provides an understanding of the spread of SEZs in China and the various financing models used. The presentation is available in the knowledge base section. c) Shanghais Rejuvenation and Pudong Development Presentation made on April 29, 2004 in the IFC/FIAS conference. It contains details about the Shanghai Special Economic Zone. The presentation is available in the knowledge base section. d) More Information about the IFC/FIAS conference on Special Economic Zones is available at: http://ifcln1.ifc.org/ifcext/southasia.nsf/Content/Special+Economic+Zones+Workshop e) Shenzhen An article from www.tdctrade.com on the Shenzhen SEZ in China. Besides providing basic details about the economy of the SEZ, the article gives an insight into the advantages and opportunities that Shenzhen offers. More information on economic opportunities in Shenzhen available on: http://www.tdctrade.com/prd/region05.htm f) Laws on Special Economic Zones in China http://www.isinolaw.com/jsp/law/LAW_Statutes.jsp?CatID=371&LangID=0 g) Website for information on Indian SEZs: designated areas and the governing laws http://www.sezindia.nic.in h) Ministry of Finance-China, site on Special Economic Zones and other coastal ports. Provides the rationale and the Chinese perspective behind these economic zones. http://english.mofcom.gov.cn/article/200406/20040600239135_1.xml

i) Special Economic Zones as engines for growth for China and the comparison with India. An article from Indiainfoline.com http://www.indiainfoline.com/lyas/nevi/sezg.shtml