Future zones

OUTLOOK/ SEZ

There's plenty to explore with SEZs.

India today is seeking to emulate the magic phenomenon of attracting investments, especially FDI, with the help of geographically separated preferential zones, promising tax breaks, world-class infrastructure and a hassle free environment.

This approach has attracted several developers with vision. While announcing the SEZ rules earlier this year, Minister Kamal Nath promised investments of around Rs 1,00,000 crore.

Today, a state like Gujarat alone has approved SEZs with investments potential exceeding Rs 1,65,000 crore. This has not only attracted big developers, but the task of attracting investors has now changed from government to developers "� an important and fundamental shift over the past.

The frustration in driving key reforms to unshackle industry and the failure to offer world-class infrastructure, has led to the introduction of SEZs in India. In China, SEZ was also started as an experiment with free market economy in Guangdong province in 1978-80, which houses the famous Shenzen SEZ.

Therefore, the question arises that how should we define a successful SEZ? Should it be as one that demonstrates unambiguously that labour flexibility and economic freedom actually bring investment and jobs and thus convinces Left for more reforms? Or, one that attracts a lot of FDI from MNCs and offers them a place to manufacture for the world and improve their profits? Or, one that primarily helps domestic companies become transnational corporates while growing exports and foreign exchange? Or, One that helps host economy to improve incomes and reduces unemployment? Or, one that ensures a good return to developer of world-class infrastructure? Or, finally, one that will help India absorb new technologies, and integrate with the global chain of goods and services?

It is thus critical to establish our fundamental objectives and then build a suitable fiscal and operational framework for a fixed period of time. Today's SEZ regime is indeed very liberal with essentially one condition, that the unit be a net exporter of US $1 in five years, to qualify as SEZ unit and claim income tax benefit.

Thus, there are implications of the SEZ unit as well as domestic tariff area (DTA) industries. There is no guarantee that the products would have high value addition, new technology absorption, major employment generation, local raw material use or getting successfully integrated into the global value chain. Hence, the question is that will large investments be realised in the near future? Yes, I am very bullish on this and the reasons are not far to see.

With the benefits of EOUs ending in 2009, SEZs remain the only area where benefits can be availed in future.

Considering that several corporates have aspirations to grow at much faster rates of 20-25 per cent every year (well over the economy rates of 7-8 per cent), manufacturers are aiming at exports in a very big way. Here SEZs, ensure their earnings and profit growth as these are the only tax haven available for exporting and aggressive corporates.

We have drawn belated inspiration for attracting FDI using the successful SEZ experience of China.

However, the Indian SEZs are fundamentally different from the Chinese SEZs, in size, ownership and management structures. Our SEZs are driven primarily by domestic investors, not FDI. Indian SEZs are typically much smaller and usually funded with private capital seeking returns on investments (requiring competitive pricing) and subsidies as against the huge, lavish, often oversized with holistic infrastructure designs and built on government funds in China.

Therefore, our infrastructure is unlikely to match the attractiveness, lavishness of the Chinese, and other global SEZs. This could mean that FDI and our own externally-oriented domestic corporates may not find India as attractive as China for expansion!

However, I feel we will score over China in another important area: though not fiscally incentivised, our domestic linkages of SEZ investments are more umbilical than the FDI-dominated Chinese zones. We should, thus, expect better sharing of benefits with the DTAs, especially through procurement of raw materials and services from the hinterland.

Whether we should have more new SEZs with tax concessions, or let the demonstration effect of the initial SEZs prove the case for implementing immediate reforms across the country is an open question. Clearly the latter is a less distortionary approach, though slower.

Another issue is that international capital is mobile and slowly even our domestic capital is getting to be mobile as well and the worry is that will such investments remain in the country even after the tax break period is over?

The live example of Electronic Estate in Gandhinagar, proves that investments tend to migrate after the tax break is over, as they did not have strong linkages with the domestic industry there. Perhaps, China will have to continue with tax breaks and other concessions, to retain several large investments.

The fear amongst several policy makers and media is that the big SEZs are, in fact, a part of a major land grabbing effort. This is supported by the fact that non productive area in an SEZ can go upto 75 per cent of the entire zone, which means that a developer can easily earn more money from building housing, entertainment parks, schools and commercial complexes than from supporting companies operating for manufacturing and services in 25 per cent of the zone.

Besides, units in the manufacturing zone are expected to trickle into the SEZ over 10 years, while the part involving township development will be much faster and economically viable, thus driving this fear further about the motivation of many developers.

I believe that this can happen, but it is not so bad provided it is of world-class quality. After all, Tata has built Jamshedpur, Sanghi has built Sanghinagar and cases abound where corporates have responsibly contributed to social development.

Governments will then become assertive and visionary in allocating large lands to corporates and developers in future. There will be close scrutiny of credentials and progressive conditionality.

New urban development, if it is world class, also needs to be welcomed, even with some tax concessions like those of SEZs. It would, in turn, catalyse investments too. Today, companies like Infosys are building their own hotels and services, entertainment etc anyway as a matter of sheer business necessity.

Look at what the Hiranandani group created in Mumbai too.

Finally, at a time when off shoring to India is aggressive across several sectors and corporates are wanting to secure growth through exports, a liberal framework governing SEZs is a very good development for the country.

However, these must be seen only as a pilot project to having country wide reforms. The challenge really remains in driving reforms country wide using the initial success of SEZs merely as a catalyst.