Issues with the SEZs and Proposed Changes under the DESH Bill – Explained, pointwise

Introduction

The Union Government is likely to introduce the Development of Enterprise and Service Hubs (DESH) Bill in the ongoing Parliament session. Through the Bill, the Government proposes to rebrand India’s 268 Special Economic Zones (SEZs) as ‘development hubs’ under the DESH bill. The Bill aims to make the SEZ Act compliant with World Trade Organization (WTO) norms and boost manufacturing and job creation. It aims to revamp the SEZ units in such a way that it becomes a win-win situation for manufacturers as well as the consumers.

What are the issues associated with the SEZs?

First, Indian SEZs are much smaller in size and performance compared to Chinese SEZs. Shenzhen’s SEZ area (49,000 hectares) (a major industrial hub in China) exceeds the combined area of Indian SEZs (47,000 hectares). Small size prevents SEZs from offering high-quality common facilities which is crucial to realize cost economies/economies of scale. As a result, SEZ attracted more units for the tax concession than for any other competitive consideration.

Second, many large-export oriented units (EOUs) were converted into SEZs. However, when tax exemptions ended, investments dried up. Due to this, today, less than half the land approved for SEZ purposes is used leading to gross underutilization of resources.

Third, under the SEZ Act, sale of goods manufactured in SEZs in domestic market attracts custom duties. However, the custom duties are levied on the entire finished good and not just on the imported raw materials (imported duty free). This acts as a big deterrent for current SEZ units.

Fourth,  In 2019, the World Trade Organization (WTO) held that subsidies provided to SEZ units in India violated the rules of fair trade.

Fifth, many States did not sync State level laws with the Central SEZ Act, which created barriers in the single window clearance regime. 

Sixth, there are multiple models for economic zones apart from SEZ like NIMZ, Coastal Economic Zones etc., which creates problems in integration of various models.

Seventh, the tax provisions related to the SEZs was changed multiple times e.g., Minimum Alternate Tax (MAT) was introduced and exemption on Dividend Distribution Tax was withdrawn. Another issue was introduction of sunset date for direct tax benefits. These frequent tax changes negatively impacted investor sentiment leading to gradual drying up of investments. In 2020, the capacity utilization of SEZs had fallen to 50%. East Asian economies like Philippines, Vietnam, Thailand etc.  tweaked their policies that attracted investments e.g., SEZs in Indonesia and Thailand enjoy Tax exemptions for 12 and 13 years respectively.

Investments of ~ INR 6.5 Lakh Crore created employment for ~27 Lakh persons. This translates to investment of ~ INR 24 Lakhs to create one job. 

How does the DESH Bill aim to improve the loopholes of the current SEZ framework?

First, the developers of the zones, (to be called Development Hubs) will get infrastructure status, which will allow them to get easier credit at competitive rates.

Second, the Bill removes the restriction that exports should be more than imports over 5 years. Now units can import any amount. They can also do invoicing in rupee to facilitate domestic transactions.

Third, the DESH framework gives more concessions to SEZ units selling in the domestic market. Units in the development hubs will be allowed to sell goods in the domestic market with customs duty to be paid only on the imported raw materials and not on the entire finished goods. Under this, if raw materials are imported at zero duty from a free trade agreement partner country, no duty will have to be paid when the final product is sold in the domestic market.

Fourth, the Bill has reportedly dropped the net forex earnings criterion for SEZ units. It will be replaced with a set of growth criteria that could include investment and employment ramp-ups as qualifiers for benefits. 

Fifth, there might be an offer of a special corporate tax rate of 15% instead of 22% to new manufacturers that start operations by March 2024.

Sixth, the revamped SEZs will be able to avail auto-renewal of licenses under the Development of Enterprise and Service Hubs (DESH) legislation, subject to conditions.

The Bill also proposes a framework to include the existing industrial parks in the DESH framework—including those of other government departments like textile parks, food parks, pharma and power.

What more steps can be taken to ensure success of the proposed Hubs?

Attracting big players: Sectoral hubs for textiles, electronics, or pharma must invite a large global anchor firm to kick-start operations. Their use of Indian ancillary and component supplier firms will benefit the entire sector as seen by the role played by Suzuki in India’s automobile sector in the early 1980s. Anchor firms of large scale will help semiconductors, electronics and solar cells sectors in increasing manufacturing and export output.

Agility: Speedy factory-to-ship movement through dedicated freight corridors (DFCs) from all hubs is a must. Each hub should figure out the Gati Shakti programme priorities.

Aim bigger: DESH should focus not just on SEZs but also on industrial parks for various sectors, manufacturing under the bond of Customs; and EOUs. These schemes offer different concessions for similar operations, creating competitive distortions. Good firms do well via core operations like R&D and manufacturing, not scheme hopping.

Checking Leakages: A GSTN-like number system can be used to monitor movement of goods. Stringent provisions should be made for small-volume high-value items like gold and diamonds to check misuse.

Exclude IT Sector: Many IT/ITES firms relocated into SEZs just to get tax exemptions. Their contribution to exports was minimal. So the Government should consider excluding the IT sector from DESH.

Transparency in Land Acquisition: There will be changes in the land-use as DESH changes focus from exports to broad economic activity. Under the SEZ framework, many developers bought land with the help of State governments, by using the ‘public purpose’ clause to acquire land. Few giant pieces of land acquired in the name of SEZs could not take off. Government should return such non-operational SEZ land to its rightful owners.

Conclusion

If governed effectively, Enterprise and Service Hubs can function as growth engines for development of the Indian economy.  These hubs can address the challenges faced by the economy, especially in the aftermath of COVID-19. The proposed DESH legislation is a step in the right direction that will also play a vital role in making India a US$ 5 trillion economy. The Government must learn the lessons from not-so-successful SEZs and ensure that the proposed hubs make India the center of global manufacturing value chains.

Syllabus: India Economy and issues related to growth, Changes in Industrial Policy and their effects on industrial growth.

Source: Mint, Mint, The Times of India, Business Standard, Financial Express,