Circa 2015: John Doe Jr., the young new CEO at one of the world's largest auto-parts companies, is on a guided tour of Reliance's Maha Mumbai special economic zone (SEZ). Doe wants to invest more than a billion dollars in a new factory, and he's weighing his options, which include India and China. His father, John Doe Sr., who last visited India in 2008, has warned him against investing in India because, as he remembers, it has a horrendous bureaucracy, convoluted regulations, and pathetic infrastructure. Yet, the young man has decided to check out Reliance's new SEZ because he's heard a lot of good things about it from some of his peers who already operate out of the SEZ.
As the Reliance chopper in which he's seated gives him an aerial view of the city, Doe Jr. can hardly believe what he sees. Forget China's Shenzhen; this city is something else. Beautifully laid out roads, clearly zoned residential and industrial areas look stunning from about 2,500 feet above ground. The numbers, which Reliance's head of SEZ offers to Doe Jr., are even more impressive. Almost a fifth of Fortune 500's manufacturing companies already have facilities in the SEZ, with investments of about $5 billion; the SEZ airport, world-class in every respect, can handle 90 million passengers a year (as much as Frankfurt airport) and 4 million tonnes of cargo. As a new city, Maha Mumbai has brought down real estate prices in the main Mumbai city and eased pressure on infrastructure. As an economic zone, it accounts for 5 per cent of India's total exports of $1 trillion. There's no red tape, there are no power cuts or water problems. What's more, there's a booming, vibrant city of blue and white-collar workers, whose per capita income is three times the national average. "Gosh, dad couldn't have been more wrong," thinks Doe Jr. "India it has to be."
As things stand today, no one knows the following: a) Will Reliance's, or any other SEZ investor's, dream of creating world-class urban centres in India ever come true? b) Will some investor, some day, go back as impressed with India's infrastructure and bureaucracy as John Doe Jr? c) Will India's exports actually hit a trillion dollars by 2015? d) Will prosperity trickle down to the poorer Indians as visibly as in the crystal-gazing above? e) Will India ever give China a run for its money?
If no one really knows, it's because the great circus that the issue of SEZs has been turned into. Farmers would rather continue living at subsistence levels than sell their land; industry wants to squeeze the maximum out of a well-intentioned plan, thereby endangering its very feasibility, and the government would rather ensure its own survival by washing its hands off a politically explosive issue than screw up courage to come up with a pragmatic policy that works in the interest of all stakeholders. Thus, a cap on SEZs, both in terms of their number and size, is thought of, and farmers are left to deal with developers directly and vice versa. With the result, a good idea runs the risk of being still-born.
| No. of functional SEZs | 19 |
| No. of valid formal approvals (with land) | 234 |
| No. of notified out of 234 SEZs | 63 |
| No. of formal approvals cleared for notification | 83 |
| No of in-principle approvals (without land) | 162 |
| Pending proposals | 370 |
| Investment made in 63 notified SEZs | Rs 13,435 crore |
| Employment created in 63 notified SEZs | 18,457 persons |
| Estimated investment if 234 formal approvals become operational | Rs 3,00,000 crore |
| Employment | 4 million jobs |
The need of the hour is to ask some important questions about the SEZs and find the right answers. Here, we make an attempt:
Q. Do we need so many SEZs or can we simply follow the China model?
This is a question that has been doing the rounds ever since the policy was first conceived in 2005. The question emanates from the tremendous success of the Chinese model. In eight years from 1980 to 1988, China established the SEZs in Shenzhen, Zhuhai, Shantou and Xiamen cities, and Hainan province. And by 2002, these free trade zones had attracted $60 billion of investments, employed two million people and were contributing 15-23 per cent to the nation's exports, according to a KPMG report. Surely this success is worth emulating. However, the Chinese SEZs are few in number and large in size. The famed-Shenzen, at best a mid-sized zone, is 327 square kilometers. The Hainan island is 34,000 square kilometers. Indian SEZs, with their cap on size at 5,000 hectares (50 sq km), are going to be midgets in comparison. Even Reliance with its proposed 10,000 hectare SEZs would have been middling at best in terms of sheer size. Fewer, larger SEZs have a compelling economic logic with their scale, and ease of administration. Anita Arjan Dass, Managing Director of Mahindra City, points out that a large size is preferred by a developer since it prevents overexposure to just one industry (as in single-industry SEZ) and protects investments. "Besides, the growth of ancillary industry development for a multi-product SEZ could be stymied in a small-sized SEZ. Today, large companies want to bring their ancillaries with them," Dass saysSEZs VS THE REST
SEZs
Units*
» Complete exemption from corporate tax for the first five years; 50 per cent exemption for next five years and a 50 per cent exemption for a further five years equivalent to the special reserves created by the units
» Complete exemption from Minimum Alternate Tax (MAT).
» Complete exemption from import duties. On procurement from the domestic tariff area do not have to pay excise, VAT, or (central sales tax) CST. Service tax is also exempt on services consumed within the zone
Developers
» 10-year tax holiday on profits derived from development of SEZs.
» Complete exemption from MAT, Dividend Distribution Tax
EOUs (March 31, 2009)
Direct Tax
» 100 per cent tax deduction on export profits
Indirect Tax
» Nil import duty
» Nil excise duty on procurement of goods from bonded warehouses in the domestic tariff area (DTA)
» Reimbursement of CST paid on purchases from DTA
EHTP/ STPI (Direct tax deduction till March 31, 2009)
Direct Tax
» Deduction of 100% export profits derived therefrom for any 10 consecutive years Indirect Tax
Nil import duty
» Nil excise duty on procurement of goods from bonded warehouses in the DTA
» Reimbursement of CST paid on purchases from DTA
Industrial Parks (Available to developers notified by DIPP on or before March 31, 2009)
Developers
» 100 per cent tax deduction is available to the developers of industrial parks for any 10 consecutive assessment years out of 15 years
Units
» Income tax holiday and exception from CENVAT is available for units set up in industrial parks in the states of Uttarakhand, Himachal Pradesh, Sikkim and Northeast, subject to certain conditions
However, can the China model be supplanted directly? No. For one, India is a democracy and free market economy. Government diktats cannot, and should not, determine economic progress. Two, skill sets vary in different regions of the country, says G.R.K. Reddy, Managing Director, Marg Constructions, which is developing over 600 acres in two adjacent locations. "Population density and per capita income also vary from region to region-so the one-size-fits-all strategy won't work. More numbers of SEZs would have to be scattered around as transporting people would be difficult," he adds. However, do we need a cap on the number? No. It's for the market to determine how many SEZs it can profitably accommodate. By restricting the number of SEZs, we will be making the same mistakes that we made by restricting manufacturing capacities and licensing industries
Q. Should there be a minimum limit on the "processing area"?
The hike in processing area (where core activity, manufacturing or otherwise, would take place) to a uniform 50 per cent of the total area has reduced the real estate play somewhat. SEZs cannot now be used as a surrogate for urban development. Srikanth Badiga, VP, Hyderabad Gems SEZ, says, "The processing area is in a sense a surrogate for industrialisation. The norm for 50 per cent processing zone is crucial to ensure that players serious about industrialisation get in and not those who are only interested in real estate development."
However, this rule also trims the returns expected by the SEZ developer considerably. "With the current norms, the returns for SEZ players have come down by 15-20 per cent, mainly due to the increase in processing area. The per-square feet realisation tends to be lower in the processing area," says Unitech Managing Director, Sanjay Chandra, while adding that much would depend on the location of the SEZ. Unitech is a joint venture partner with the Salim Group and Universal Success Group at the proposed SEZ at Nandigram and surrounding areas. So, should there be a minimum limit? Yes. And does the 50 per cent limit still leave enough on the table for developers? Yes, again.
Q. Should there be a maximum limit to the size of SEZs, like the 5,000 ha cap set by the government?
No. It just doesn't make any sense. Just as no automobile manufacturer makes 200-ft-long cars, no developer will make an SEZ bigger than what he can profitably sell. Remember, there's cost to every sq. ft of land developed. Yet, flexibility in terms of size is important to create a competitive and efficient economic region. "Certain infrastructure costs like cargo handling, power costs, port development would make sense only if the SEZ is really large in size," says Mahindra City's Dass, adding that her firm is comfortable with the current size of 1,300 acres, because "we feel that this is the size that we can optimally manage."
However, should the developer have an appetite for larger areas, there is no economic or financial rationale for the cap of 5,000 hectares. The sole reason this ceiling seems to have been incorporated is to cater to the demands of the intransigent government allies, notably the Left Front, which was caught on the back foot in its own back yard when violent protests in Nandigram broke out. Does it create problems? Not really. There were just a handful of SEZs that were larger than this cap. But, as Mukesh Khandelwal of infrastructure consulting firm, Feedback Ventures, says, "5,000 hectares is still a fair amount of land for SEZ development." Finally, if any developer wants to go round the cap, he'll find ways to do it.Q. Should the government help with land acquisition?
No. Let the farmers decide if they want to sell their land and at what price. Forcible acquisition of land, which is what the government's 'eminent domain' right ensures, will always be resisted, and rightly so. But will the government's non-involvement make land acquisition more difficult? Yes, it will. But that's a good entry barrier to SEZs, and something that will automatically prevent oversupply of SEZs into the market. However, the government may still have a limited role to play. Videocon Group Chairman, Venugopal Dhoot, who currently heads business chamber, assocham, says there are practical issues in private land acquisition, as some states have land ceiling acts on transfer of land into private hands. "The state governments should be involved at least in things like acquisition notices. The private developers can take charge of the financial transactions."
N.D. Mehra, Head Commercial & Legal, DS Constructions, believes that without government intervention the stipulation of contiguity of land-one of the requirements of the multi-product SEZs-would be affected. Contiguity is a mandatory requirement of the SEZ regulations and is critical for success. "For an SEZ to be successful it must be self-sustaining, containing all the requisite infrastructure, utilities, facilities and services."
At any rate, the combination of a cap on the maximum size of the SEZ and the government withdrawal from land acquisition is quite unsustainable. "If the government is not going to help in land acquisition then capping the maximum size does not have any logic," points out Mehra of DS Constructions.
The government, especially the Prime Minister's Office, seems to be veering around to the view that some government aid is in order especially if the private developer acquires, say, 75-80 per cent of the land required. That seems to be a reasonable demand, since private purchase would have already 'discovered' a market price for the land that the government can order the 'problematic' landowner to accept.
Q. Will there be a revenue loss to the exchequer on account of special economic zones?
This is a chicken-and-egg question. Sure, the revenues foregone on business that would come up in SEZs would be a loss. However, the question that follows then is-in the absence of the SEZ policy would that business set up shop in India at all? The finance ministry did put forth its apprehensions of a revenue loss, yet the considered view of the government was that the advantages accruing from the SEZs would far outweigh any possible revenue loss on their account.
With regard to existing businesses moving into SEZs, there are enough safeguards to ensure that domestic market-oriented companies find it prohibitively expensive to sell to the domestic tariff area after producing the goods in the SEZ. In most cases, imports would be cheaper. So these apprehensions are mostly misplaced.
HURT BY THE CEILING
Developers may still work around the ceiling problem, but these are the ones that will be the most affected.
| Reliance's Maha Mumbai project | 10,000 hectare |
| Reliance's Jhajjar (Haryana) SEZ | 10,000 hectare |
| DLF's multi-product SEZ in Gurgaon | 8,097 hectare |
| Omaxe project in Rajasthan | 6,070 hectare |
| Bharat Forge, Pune | 7,000 hectare |
Where they could have some credibility is in case of SEZs that are oriented towards it and it-enabled services. Many of them are planning to shift incremental business to SEZs due to the expiry of sops under STPIS and others. However, here too it is the overall operating business environment that makes SEZs attractive. For instance, for business process outsourcing companies, 40 per cent of the advantage of working in India comes from cost alone. If the overall operating cost in India gets mitigated by moving to an SEZ, then that is hardly bad news. As Rohit Kapoor, CFO, EXL Services, says, "Business policies are making operating in India quite expensive. Destinations such as Vietnam, the Philippines, South Africa and East European countries are becoming increasingly attractive." An it SEZ, then, will make India more attractive compared to rival countries.
Q. Are SEZ developers fighting shy of resettlement and rehabilitation expenses?
Not really. India Inc. in general is not apprehensive about adequate compensation for the land owners and users. "It is a good step as there would be greater clarity to the process," says Unitech's Chandra. Videocon's Dhoot concurs that the private sector is quite agreeable to all the possible means of appropriate compensation-market-linked land rates, employment assurances for land owners' family members and even equity options. However, "the government has to be involved in the land acquisition process," says Dhoot.
The same sentiment is echoed by Amit Mitra, Secretary General, ficci, who says that the R&R policy will formalise and put in place systems and processes for smooth transition. As it is, companies do acquire land privately even now. "We have to be inclusive in a very pragmatic manner. There is certainly a requirement for intermediation to generate employment for landless labourers or share-croppers, and public-private participation could help in such areas," Mitra adds. The bottleneck in firming up the policy is going to be at the level of the states, since so many of them need to agree on the modalities that they will have to ultimately implement.
Q. Are the long delays in firming up the SEZ policy putting off investors?
For now the investors have shown patience, as the total incentives for the SEZs outweigh those from comparable destinations. Three footwear SEZs, including Taiwanese company Apache, are moving from China to India on the back of the attractive investment policies. Ascendas, which has commitments from Japanese manufacturers, has also been waiting in the wings. The question is, how long will they wait? Too much dilly-dallying will change the climate soon enough. As it is, some investors are getting fidgety. Destinations such as Vietnam and Poland beckon. The Nike supplier from India, Lotus Footwear, apparently is looking at Vietnam as an alternate investment destination.
Investors can live with restrictions, but with uncertainty they choose not to. It's time the government ended the uncertainty over SEZs.