Fading SEZ appeal

News: Recently the government has started working on replacing the Special Economic Zones (SEZ) Act, 2005, with a new law.

Why such change?

The finance minister has indicated that the updated legislation would enable states to become “partners in the development of enterprise and service hubs”. It may also allow SEZ units to sell in domestic tariff areas and accept rupee payments. However, it dilutes the concept.

How SEZs have performed in India?

One, India was among the first Asian countries to experiment with this concept in the 1960s. Many export-processing zones and export-oriented units were created. However, it did not yield the expected boost in exports.

Two, China’s economic success built on its free trade zones motivated the United Progressive Alliance government to follow same path. SEZ developers and firms were given various tax exemptions such as Exim duties, excise, and a 15-year tax holiday on profits.

But 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.

What is the reason for under-performance of SEZ?

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.

Second, huge SEZs were created in China under state support, which allowed for massive economies of scale. But the Indian law allowed for seven types of zones, such as for multi-product or a single sector.

Also, the most SEZs were small between 100 and 200 hectares and many as little as 10 hectares. These SEZs did not contribute to price competitiveness.

Third, 70 per cent of the SEZs were in the IT and ITeS sectors, which were already having enough competition and did not require extra benefits. Also, the share of job-creation in manufacturing has been consistently low due to poor transport and other linkages.

Fourth, there were serious flaws in land acquisition practices. Proposals for big single-product zones over 1,000 hectares were opposed by people. For example, farmers are mostly unwilling to sacrifice settled livelihoods for uncertain and sub-par compensation.

Also, protests affected both private-sector’s attempts to acquire land and state governments’ efforts to acquire it on their behalf.

Fifth, policy instability and gradual withdrawal of tax breaks reduced the attractiveness of SEZs. For instance, 101 applied for denotification between 2008 and 2020.

What is the way forward?

There is need to learn lessons from past failures. Creating investment hubs can work only if the whole country is geared to that end.

Source: This post is based on the article “Fading SEZ appeal” published in Business Standard on 18^th Feb 2022.