One of the most common refrains against the SEZs has been that they failed to achieve their intended objective of encouraging manufacturing exports from India and instead became attractive centres for information technology firms to avail of tax incentives by shifting to the zones from domestic tariff areas. Photo: Ramesh Pathania/Mint (Ramesh Pathania/Mint)
One of the most common refrains against the SEZs has been that they failed to achieve their intended objective of encouraging manufacturing exports from India and instead became attractive centres for information technology firms to avail of tax incentives by shifting to the zones from domestic tariff areas. Photo: Ramesh Pathania/Mint
(Ramesh Pathania/Mint)

Study lists why India’s special economic zones policy didn’t work

Incentives offered under the foreign trade policy to exporters outside of the zones and disincentives arising out of FTA snagged the policy

New Delhi: They were supposed to be Chinese-style, self-contained industrial enclaves aimed at turning India into a powerhouse of manufacturing for exports, but things haven’t quite gone according to plan.

In its initial findings, a study commissioned by the commerce ministry now proffers two reasons why the Special Economic Zones (SEZs) didn’t work. Incentives offered under the foreign trade policy to exporters outside of the zones and disincentives arising out of free-trade agreements (FTA) snagged the SEZ policy, the study has found.

The commerce ministry commissioned the think tank Indian Council for Research on International Economic Relations (ICRIER) to do the comprehensive cost-benefit analysis of the SEZ policy.

Arpita Mukherjee, a professor at ICRIER who is heading the study team, said the implementation of the foreig

“In a way, you created zones to promote exports and disincentivized such activity by giving more export benefits to units outside such zones," she said.

The commerce ministry provides incentives to exporters outside SEZs through the duty drawback scheme, and focus market and focus product schemes, among others.

The duty drawback scheme allows manufacturers to seek a refund of duty paid on imported materials used in the manufacture of goods which are exported; the focus market and focus product schemes incentivize exports to specific geographical regions and specific products.

Mukherjee said ideally such benefits should also have been extended to SEZs to ensure a level playing field.

“The situation further aggravated with the global economic downturn of 2008-09 when demand for Indian goods fell drastically and duty-free sale of SEZ products within the country was not allowed," she said.

Since the SEZ policy was announced in 2000, 576 formal approvals have been granted for setting up of such enclaves, out of which 392 SEZs have been notified. Only 170 are operational.

One of the most common refrains against the SEZs has been that they failed to achieve their intended objective of encouraging manufacturing exports from India and instead became attractive centres for information technology firms to avail of tax incentives by shifting to the zones from domestic tariff areas.

To be sure, SEZs have access to duty-free imports of manufacturing inputs because technically they are considered to be outside of the country’s domestic tariff area. But, with India signing free-trade agreements with countries where duties on many products are eliminated or reduced substantially, the advantage accruing to SEZs was negated, Mukherjee said.

“Such a situation does not arise in other countries since their differential tariff rates are much lower than India," she said.

India has free-trade agreements with countries such as Sri Lanka, Japan, South Korea and the Association of South-East Asian Nations, which groups Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam.

The ICRIER study was commissioned in April this year against the backdrop of declining interest in SEZs after the government imposed a minimum alternative tax on SEZ units in April 2012 and to examine many negative perceptions about the industrial zones.

The commerce ministry also asked ICRIER to examine the impact of foreign trade policy and the regulatory framework as well as analyse incentives provided under free-trade agreements signed by India with other countries and their effect on the SEZs.

Mukherjee pointed to a difference between the models followed by China and India— while China created a limited number of large, self-sustainable, confined enclaves near port facilities to boost exports, India opted to license a large number of SEZs without ensuring proper infrastructure outside the zones.

There is another hurdle that SEZs face. Tax incentives granted to SEZs are seen as breaching World Trade Organization rules that bar financial contributions by a government or public body.

Units in SEZs still enjoy income-tax benefits. Mukherjee said countries impose countervailing duties to negate direct tax subsidies, which reduces the competitiveness of exports from such enclaves.

So far, 33 countervailing duty measures have been slapped on against India, second only behind China (42).

“We have to substitute such tax incentives to SEZ units by subsidies on inputs, which are used in production of exports material and are not considered subsidy under WTO rules," Mukherjee said.

Looking at SEZs only from the incentives perspective is a narrow approach to the problem, said Biswajit Dhar, director general, Research and Information System for Developing Countries, a think tank under the external affairs ministry.

“SEZs were supposed to be areas where government provides state-of-the-art technology and infrastructure facility. However, later they were left to private developers. We should go back to the original idea and develop such zones as pockets of excellence," he said.

SEZs should provide better infrastructure facilities, which in turn will reduce the cost of operations and act as an incentive for exports, said Ajay Sahai, director general of the Federation of Indian Export Organisations.

“When it comes to allowing SEZs to sell in domestic market, one has to take into consideration the concerns of the domestic manufacturers," he said.

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