Home / News / India /  Coastal sunrise must follow sunset on SEZs

In a way, 2020 signals the end of SEZs. For developers of Special Economic Zones (SEZs), the sunset clause for income-tax exemptions kicked in in April 2017. For units in SEZs, the sunset clause became effective in April 2020. Ergo, both on direct and indirect taxes, there are no fiscal concessions.

By the end of July 2020, there were 357 notified SEZs, in addition to 7 Union government and 12 state government/private SEZs that were established before the SEZ legislation of 2005. There were 5,524 units in SEZs. However, by end March 2020, only 248 SEZs were operational. Most private operational SEZs were in IT/ITES and enthusiasm for SEZs tapered off around 2017.

In absolute terms, growth in exports from SEZs might seem impressive, but as a share of exports, they never became the driver they were expected to be.

In the World Bank’s Logistics Performance Index (based on customs, infrastructure, international shipments, logistics competence, tracking and tracing and timeliness), India’s score and ranking have consistently improved. But logistics isn’t only about what happens at the port; it is also about transport infrastructure. That is, it is also about what happens inside borders, though for IT/ITES, physical infrastructure is less of an issue.

If one ignores Himalayan states and the North East, major coastal states are Andhra, Gujarat, Karnataka, Kerala, Maharashtra, Odisha, Tamil Nadu and West Bengal. While it is difficult to unambiguously identify any export as originating from a specific state, one would expect exports (at least the merchandise variety) to originate from these states and not from landlocked states like Assam, Bihar, Chhattisgarh, Haryana, Jharkhand, MP, Punjab, Rajasthan, UP, Telangana or J&K.

Except for the rare or perishable item, air freight makes exports uncompetitive. Indeed, 70% of exports originate from Maharashtra, Gujarat, Karnataka, Tamil Nadu and Telangana. At best, one can ask, why don’t Andhra, Kerala, Odisha and West Bengal perform better?

Export enigma
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Export enigma

Whether it is a recent export preparedness ranking done of the states, or Economic Survey’s data, we will have Gujarat, Maharashtra and Tamil Nadu at the top. Once one takes away the USP of fiscal concessions, for most exports, competitive advantage only exists along the coast, where seaports are.

That’s the reason, as part of the Sagarmala Project, the idea is now to have coastal economic zones (CEZs), coastal economic units (CEUs) and port-led industrial development and exports. This is what SEZs should have been in the first place, as the first lot of Export Processing Zones were.

With tax concession-induced SEZs out of the way, these CEZs (at least the first set) will be in Gujarat, Maharashtra, Goa, Karnataka, Kerala, Tamil Nadu, Andhra, Odisha and West Bengal, with specific links to ports and manufacturing catchment areas in specific districts.

Any enclave-driven liberalization needs to have focus, like CEZs, and cannot be indiscriminate, like SEZs. To understand this shift, we have to first examine why India’s policy makers chose to blindly follow the Chinese model.

The early days

China’s SEZs (Shenzen, Zhuhai and Shantou in Guandong province and Xiamen in Fujian province) were established in 1980 with objectives of stimulating exports and attracting foreign direct investment (FDI) and new technology. The objective wasn’t the transformation of the fishing village of Shenzhen. That was an indirect consequence. In those early years, China liberalized selectively, in enclaves.

As liberalization spread, an entire province like Hainan, not just a geographical area within a province, became an SEZ. As liberalization spread further, coastal cities were added to such enclaves, though these weren’t de jure SEZs. The adjective “coastal" is critical. SEZs and these cities were along the coast, close to Hong Kong and Macao.

Chinese SEZs were successful by any yardstick (shares of exports or FDI inflows). But as liberalization extended beyond enclaves, those shares declined. The Chinese did it in 1980. India sought to do it in 1965. Kandla Free Trade Zone (FTZ) was inaugurated by the then Prime Minister Lal Bahadur Shastri in March 1965.

The noted civil servant, Nagarajan Vittal, spent part of his career as Development Commissioner for Kandla FTZ. His wife, Gita Vittal, wrote her memoirs (in 2007) and mentioned what N. Vittal said when he was offered a post 13 others had refused. “For nine years the zone has been a failure. If I go and fail, I will be one more on the list of failures, but if I succeed, I would have done something worthwhile." Despite Vittal improving matters a bit, Kandla failed, compared to what it was expected to achieve.

Other than Kandla, we had Santacruz Electronics Export Processing Zone (EPZ) in 1973, Chennai, Falta (in West Bengal) and Cochin in 1984, Noida in 1985 and Visakhapatnam in 1989 (it became functional in 1994). We often forget there was limited import liberalization in 1976. We certainly forget that in 1976, Union Cabinet turned down a proposal to start EPZs in Calcutta, Chennai (Madras) and Cochin.

The argument advanced against the EPZ proposal was no different from an issue confronting us today. If there is general import liberalization, elimination of QRs (quantitative restrictions) on imports and reduction in tariffs, what’s the point of FTZ/EPZ? But regardless of that 1976 Cabinet question, EPZs did result.

So, what’s the difference between free port, FTZ, EPZ, SEZ And FTWZ (free trade and warehousing zone)? The terms are often used as synonyms. If nomenclature is carefully used, a rare occurrence, FTZ is a duty-free area, primarily for warehousing and distribution, such as for re-exports. Ergo, FTZs tend to be near ports or airports.

EPZs incentivize not just re-exports, but also exports. A unit in an EPZ can also typically sell in the domestic tariff area (DTA). Recognizing links between trade and investments, SEZs target inward FDI. A free port is a large geographical area that encompasses all these objectives. In 1980-81, the 100% export-oriented unit (EOU) scheme was started, duplicating every incentive FTZ/EPZ possessed, without locational restrictions.

China’s successful formula

Why did SEZs succeed in China? In a long list of answers, there will be proximity to coasts; networks, and not just proximity, with Hong Kong and Macao; de facto greenfield infrastructure and real estate development; simple procedures; FDI; and cheap and flexible labour supply because of China’s “hukou" system (until 1995, China lacked basic labour rights).

India’s FTZs/EPZs were constrained by lack of links to anything like Hong Kong or Macau, inferior infrastructure, complicated procedures, rigid labour laws and non-availability of skilled labour. For instance, restrictions on sales to DTA led to additional procedural hassles and didn’t simplify matters. Consequently, labour-intensive manufacturing and exports never took off.

As with China, if liberalization extends elsewhere, enclaves become less attractive. So, 100% EOUs could be set up anywhere, closer to raw material sources, where ecosystems, suppliers and skilled labour existed, where infrastructure was better. One shouldn’t forget, one of Kandla FTZ’s objectives was industrializing a backward region, hardly what FTZ was expected to do in any other country.

In 1980, the Tandon Committee on export strategies criticized the then solitary FTZ for being unclear in objectives, a bane of subsequent EPZs too. Not surprisingly, till 2000, the share of all FTZs/EPZs in India’s exports gradually increased to around 4.5%, much lower than expected.

Instead, 100% EOUs thrived, until withdrawal of direct tax exemptions in 2012 made the scheme unattractive. (GST removed customs duty and excise benefits, not to speak of EPCG and duty drawback, available for non-EOUs too.) Withdrawal of such fiscal incentives tilted the balance towards SEZs.

SEZs were first mentioned in Exim Policy for 2000-01. A few sentences from the then commerce minister Murasoli Maran’s speech will identify the rationale.

“I am proposing a major step of establishing, as in China, SEZs in different parts of the country…The idea basically is that in these areas export production can take place free from the plethora of rules, and regulations governing import and export…Any State Government or corporate entity or individual can furnish proposals for setting up such zones...In the meanwhile, it is also proposed to convert the existing Export Processing Zones into SEZs ."

In 2000, we thought of an enclave idea China had given up.

The instances the commerce minister gave of simpler rules were about taxes and tax-related concessions. In the tax reform agenda, both direct and indirect, fiscal concessions were on their way out, even if implementation of the agenda took time. Therefore, unless there was some other competitive edge, like 100% EOUs, SEZs were bound to wither away.

In addition, with a desire to incentivize states to push the export cause, state governments were allowed to have their own SEZs, with some promised fiscal support. There was mention of IDA (Industrial Disputes Act), but there was never any question of labour laws in SEZs being different from general labour laws. Article 14 of the Constitution doesn’t permit “hukou" or differential labour laws between an enclave and the rest of the country.

The labour issue

It was unrealistically hoped (in 2000-01) that SEZs would have distinct and more flexible labour laws. That’s not possible. But there is a caveat. This is possible under Article 243Q(I) of the Constitution, for an industrial township. National Investment and Manufacturing Zones (NIMZs), distinct from SEZs/CEZs on grounds of governance structure and exit policies, represent that idea.

Several NIMZs have been approved. I am sceptical of those located away from DMIC (Delhi Mumbai Industrial Corridor) and DFCs (Dedicated Freight Corridors). There is no getting away from physical infrastructure. The others are likely to follow the failed SEZ route.

Three decades ago, at a seaport, I watched cargo (food-grains) being loaded on a ship. Labourers carried them up on their backs, in gunny bags. I had expected more mechanization. When I asked, I was told imports were more mechanized. Why? “Gravity makes it easier," said one expert. “We mechanized imports during PL-480 days, but not exports," said another. Both self-proclaimed experts might have been wrong. But the anecdote has a point.

There is an export culture in India that transcends policies. Policies historically encouraged import substitution and fettered this culture. Therefore, the act of exports required subsidies and fiscal concessions. In a broader context, we face the issue of devising World Trade Organisation-compatible incentives, since export subsidies are not WTO-compatible. In the narrower enclave liberalization context, SEZs/CEZs will also have to look beyond tax concessions. The states need to recognize multiplier benefits from exports; and not be interested simply because there is central fiscal assistance.

In that sense, the right lessons still need to be learned from SEZs elsewhere in the world, including China of the 1980s.

Bibek Debroy is chairman, Economic Advisory Council to the Prime Minister

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