Special Economic Zones in India: The law and the experience

In this paper, the author analyses the motivation, framework and the socio-economic impact of India’s Special Economic Zones (SEZ) Act of 2005.

By Siddharth Singh

Special Economic Zones (SEZs) have been touted to be magic pills for nations to kick-start exports, develop infrastructure, and increase employment by adhering to the principles of free markets and minimum distortions caused by effective administration and low or no taxes (Tantri, 2010, p26). Owing to the success of China and other countries, India took up the development SEZs with much
enthusiasm, but the outcome has not entirely been as desired. On the one hand, the Ministry of Commerce and Industry reports impressive figures to show how SEZs have “worked” (discussed below), but on the other hand, there are cases such as that of Nandigram, West Bengal (The Telegraph, 2007) where 14 people died in March, 2007 while protesting against the establishment of a chemicals hub SEZ by an Indonesian developer (Manoj, 2009, p355 and Dohrmann, 2008, p75).

In an attempt to understand India’s experience with SEZs, this essay will first look into the
motivations of setting up SEZs. It will then assess the framework the SEZ Act
of 2005, and finally, move on to scrutinise the social and economic impact of
this policy.

The Rationale of the SEZ

An SEZ is a geographically delimited area administered by a single body, offering a certain
incentive regime to businesses which physically locate within the zone (The
World Bank Group, 2008, p2). An Export Processing Zone (EPZ) is a type of SEZ
which is legally defined as a “policy enclave” within the host state territory,
to which distinct regime of custom and trade regulations apply (Muchlinski,
2007, p226). These policy enclaves are instruments to realise micro and
macro-economic, and political objectives. Microeconomic issues include
employment generation, while political objectives include implementing regional
economic development strategies (Guangwen, 2003, p20).

The SEZ is a subset within the geographical boundaries of the state. The rest of the host
state is legally referred to as the Domestic Tariff Area or the DTA
(Muchlinski, 2007, p229). Effectively, the SEZ is “outside” the territory of
the host state with respect to trade and investment. Figure 1 below explains
this relationship.

Figure 1

The host states can expect inter alia to earn increased export earnings, benefit from
increased employment opportunities, improved training and skills, and transfer
of modern technology (Muchlinski, 2007, p227). In return, foreign investors are
offered incentives such as tax exemptions, duty free imports, exemptions from
import quotas, capital mobility to remit profits, export allowances and
subsidised interest rates within the SEZ. A significant incentive offered by
the host state involves the legal control of labour relations. Specifically,
the right to establish trade unions or take industrial action may be limited
within the SEZ (Muchlinski, 2007, p229).

Political and economic stability, reliable infrastructure, inexpensive labour, market access,
and efficient bureaucracy are factors that determine not only how attractive
investors will find the SEZ, but are factors that eventually determine the
success of the SEZ (UNIDO, n.d., p27).

Keeping in mind these objectives and demands, India embarked on a journey to use SEZs as
engines of economic growth. India set up Asia’s first EPZ set up in Kandla in
1965. The government announced the SEZ policy in April 2000, claiming to “to
overcome the shortcomings experienced on account of the multiplicity of
controls and clearances; absence of world-class infrastructure, and an unstable
fiscal regime and with a view to attract larger foreign investments in India”
(SEZ India, 2011a, Introduction). The Foreign Trade Policy provisions governed
SEZs in India prior to the implementation of the SEZ Act, 2005 in February,
2006 (Chandrasekhar and Ghosh, 2007).

Salient Features of the SEZ Act (2005)

‘The Special Economic Zones Act, 2005’ was passed on the 23rd June, 2005, in an attempt to
give a framework to the implementation of SEZs in India. It includes several regulatory and investment fostering mechanisms.

i. Creation of SEZs and general administration:

The Act explicitly mentions a few guiding principles for the Central Government
regarding the creation of SEZs. The objectives of the government, as stated by
the Act, must be to generate additional economic activity, promote exports of
goods and services, create employment opportunities, and develop
infrastructure, all while maintaining the “sovereignty and integrity” of India
(SEZ Act, 2005, p8). Thus, SEZs have thus come to be justified as an engine of
growth and employment generation, and not in terms of exports expansion alone
(Sharma, 2009, p18).

The Act calls for the creation of the “Board of Approval”, which, as the name suggests, looks
into applications to set up SEZs and gives approval to them if they meet the
required criteria. This acts as a single-stop-shop for investors (called
‘developers’) to get the required regulatory permission to set up an SEZ. SEZs
may be established under this Act either jointly or severally by the Central
Government, State Government of any legal person. The Central Government,
however, can suo moto set up SEZs, and can prescribe other requirements
at a later stage (SEZ Act, 2005, p1-6).

The position of a Development Commissioner is established (p14), and this position is responsible
for the general overview of the SEZ, from presiding over the Approval Committee
(p17-18) to running the SEZ Authority, which is in charge of provision of
infrastructure, promoting exports. reviewing the functioning and performance of
the SEZ, and other such functions (p28-29).

ii. Tax Exemptions, Finance and Banking

By definition, SEZs are so-called “tax havens”. The Act specifies all those taxes and duties
that the developers would be exempted from in the SEZs. There is exemption from
Custom Tariff Act, 1975, Central Excise Act, 1944, Central Excise Tariff Act,
1985 and other similar laws (p24). 100% Income Tax exemption on export income
for the first 5 years, and 50% for the next 5 years is offered (SEZ India,
2011a, Facilities and Incentives).

Attention is also given to the trade between the SEZ and the DTA. The Act (SEZ Act, 2005, p8)
prescribes the exemption from the payment of duties, taxes or cess under all
enactments of the First Schedule for trade between DTA to SEZ. However, any
goods moved from the SEZ to the DTA would be subject to safeguarding duties,
anti-dumping regulations and other instruments (p26).

The Act also specifies the financial governance structure of the SEZ. Bank branches in SEZs,
for example, are defined as ‘Offshore Banking Units’ (SEZ Act, 2005, p3-4), and
can be set up after the approval of the Reserve Bank of India (RBI), which is
India’s central bank (p20). Other financial activities in the SEZ would be
monitored by the relevant regulatory authorities in the DTA (p21).

iii. Law Enforcement

Were illegal activities to take place, the Act states that the Development Commissioner
would have the cases investigated, and the cases would be heard at the court(s)
appointed by the State Government and the Chief Justice of the state High Court
(SEZ Act, 2005, p22). The Act also explicitly states that in case there is any
inconsistency of this law with other laws, than this Act would have an overriding
effect over others (p34).

iv. Amendments

Over the years, several amendments have been made to the Act. They have primarily revolved
around specifying the provision of infrastructure and requirements for
establishment of SEZs. The minimum area requirements vary across industries and
regions. As an example, a multi-product SEZ has to be between 1000 and 5000
hectares, and at least 50% of the area needs to be earmarked for developing the
processing area (SEZ India, 2010, ch II sec. 5, sub-sec 2 a).

Amendments also allow for the generation, transmission and distribution of power within an SEZ
(sec. 5, sub-sec 5 c). Importantly, in the case of an information technology
related SEZ, 24 hours of uninterrupted power supply is to be provided, apart
from reliable connectivity (sec. 5, sub-sec 5A).

Importantly, a stated objective is the generation of positive net foreign exchange earnings,
as it is specified that a unit would achieve positive net foreign exchange,
calculated cumulatively for a period of five years from production (ch VI sec
53).

The Act is clear in specifying the framework regarding the implementation of an SEZ promotion
strategy. The Act however, remains conspicuous in its silence on land
acquisition and labour laws, which has become the bone of contention on the
implementation of the policy.

A Brief Overview of SEZs in India

Prior to the enactment of the SEZ Act, 2005, there were 19 SEZs across India. The government
has now approved 581 SEZs (SEZ India, 2011b) with a further 154 with in-principle
approvals (SEZ India, 2011c). 130 of these SEZs are operational today. 283 of
the 581 approved SEZs are in the three states if Andhra Pradesh, Maharashtra
and Tamil Nadu (SEZ India, 2011d). Of the sectors, the Information Technology
and IT enabled services sector has a 61% share of SEZs, while the biotech,
pharma, textile sector and multi-product SEZs have less than 10% share each.
Apart from these, there are three airport based multi-product, and eight
port-based multi-product SEZs (SEZ India, 2011e).

Source: SEZ India, 2011e

The Indian experience in the implementation of SEZs has brought to light major areas of
concern in the economic and social spheres. In the economic sphere, these are
related to fiscal costs, net employment generation and exports. The social
experience of SEZs has brought up issues of worker rights, and those of land
transfer, dispossession and displacement. The next two sections of the paper
will look into these briefly.

 

The Economic Experience

i Fiscal issues and investment:

Tax holidays in the SEZ are generous, and provide 100% exemption for Income Tax on profits for
the first 5 years of production and 50% for the next five years, apart from the
tax breaks discussed above. In addition to this, land is given by the
government to developers at low rates (Dutta, 2009, p23). Estimates by the
Finance Ministry show that the losses to the state exchequer in terms of
forgone revenue would be £24billion for an investment of £50billion
(Chandrasekhar and Ghosh, 2007).

Owing to the perceived lost revenue, the Finance Ministry announced a Minimum Alternate Tax
on the book profits of developers and units operating in SEZs in the 2011-12
Budget. The Commerce Ministry, however, wants to see a roll back of this tax
and sees SEZs as “engines of growth” (Pannu, 2011). This points to differences
between the Finance Ministry and the Commerce Ministry on the issue of SEZs.

In fact, Arunachalam (2010, p25) shows that the investment as of 2009 in approved SEZs
stood at £416million, and not the figures cited by the Finance Ministry. He argues
(2010, p20) that Indian SEZs failed to attract FDI as it would have liked
because firstly, India has not used SEZ policies to test reforms which would
later be adopted nationwide; secondly, Indian SEZs are small in size
(especially when compared to their Chinese equivalents), and finally, because
of the lack of labour market flexibility.

ii. Exports:

The Ministry of Commerce and Industry claimed that the value of exports from functioning SEZs
increased from £1.9billion in 2003-04 to £30.6billion in 2009-10 (exchange rate
£1 = INR72 as of 16th March, 2011). The growth rate of exports over the
previous years increased from 25% before the SEZ Act, 2005 to 52% after its
implementation, and it stands at 121.40% in 2009-2010 (SEZ India, 2011a, Export
Performances). Note that these figures are inconsistent with the estimates of
losses by the Finance Ministry.

An example of a successful SEZ in this regard would be the Mundra SEZ. This SEZ houses India’s
largest private port, has been most successful in seeing an increase in
exports. It is expected to handle 100m tonnes of exports by 2013, with a growth
rate of 40% in these years (Thakkar, 2008).

However, the Comptroller and Auditor General of India has pointed out that most of the SEZs
sell goods within the country as “deemed exports” rather than actually
exporting them overseas. This seems plausible as the exponential rise of
exports from SEZs corresponds with stagnant national exports. The Finance Ministry
speculates that some units have merely shifted to these zones from the DTA to
avail tax benefits (Pannu, 2011).

Source: SEZ India, 2011a, Export Performances

iii. Employment generation (or the lack thereof):

Proponents of SEZs have claimed that SEZs lead to employment generation, in addition to
exports. While the total employment by all types of SEZs across India as of
2008 was about 370,000 (Reddy, Prasad and Kumar, 2010, p87), Mahanta (2010,
p199) shows that acquisition of agricultural land by SEZs lead to a fall in
food-grain output and agricultural employment. Importantly, he shows that this
fall in agricultural employment is not offset by the increase in employment in
SEZs.

Another point to note is that compared to countries around the world, Indian SEZs have not seen
a high proportion of female workers. In 2003, only 37% of the workforce was
female (Varma, Prasad and Krishna, 2010, p320-322). The claims of benefits of
the generation of employment by SEZs are hence called into question.

The Social Experience

 

i. Land acquisition and displacement

Land acquisition is the ‘hot topic’ of India’s SEZ policy. The SEZ Act, 2005 makes no mention of
it. The out-dated Land Acquisition Act, 1894, is applicable in this regard.
Even the Land Acquisition (Amendment) Bill, 1998 has come under fire from for
several shortcomings. For instance, land losers could have their land acquired
even if a stated compensation isn’t paid (Asif, 1999, p1564).

Land acquisition is especially contentious and problematic when the land being acquired is
populated with people living off the land, which is often the case with
agricultural land, as was the case in Nandigram, West Bengal. In addition to
this, Chandrasekhar and Ghosh (2007) argue that real-estate developers can
engage in major land grab in the guise of setting up SEZs as the SEZ rules
require only 25 per cent of the land to be used for industrial processing
purposes.

While approved SEZs are to consume 95,000 hectares of land, (Balasubramanian, 2010, p53), the
Ministry of Commerce stated that as of 2008, the land allocated to SEZs was
about 0.070% of the total land area and 0.128% of the total agricultural area
of the country (Reddy, Prasad and Kumar, 2010, p87). While this may seem low,
it is has proven to be problematic because of the high population density in
some of these areas.

An illustration of the flawed acquisition mechanism by the government would be the case of the
state of Andhra Pradesh, where land is being acquired from the poorest people
who had been earlier allocated land by the government in “land-for-the-poor
schemes”. Legally, this land belongs to the government, so the government takes
it back often without compensation on the behalf of SEZ developers (Oskarrsson,
2010, p368).

On the other hand, the Commerce Ministry has cited examples of how rise in land rates in
barren, unproductive land has brought wealth to the poor and SEZs have brought
infrastructure to the hinterland, as is the case with Mundra in the state of
Gujarat (Bhatt, 2007). The wastelands in the coastal regions of Gujarat are
mostly owned by the government, hence leaving out land acquisition out of the
picture. Moreover, states like Tamil Nadu have seen the rural population
welcome SEZs, because several years of social upliftment by the government has
made the populace less dependent on agriculture for their livelihood (Murugesan
and Bandgar, 2010).

ii. Labour relations

While the SEZ Act, 2005 makes no mention of changes in labour law, Tanwar (2010, p231) writes
that changes to the prevailing pattern of application of labour laws
have been made in SEZs. All units operating in SEZs are categorised as “Public
Utility Service”, meaning that many labour laws become irrelevant. A Public
Utility Service is defined to be a service that is of great value to the
society, and the lack of provision of which can affect the life of everyone. In
this case, employees have to give a 14 day notice before going on strike.
Additionally, employees in SEZs don’t have protection in the form of a notice
period or compensation against retrenchment. It follows that employees will be
reluctant to raise a voice against their employers when the need arises.
Moreover, employers in SEZs have the right to change the terms and conditions
of service at any point of time. Mahanta (2010, p200) raises concern regarding
the lack of labour unions, stating that the possibility of fall in real wages
is high, although experience shows that SEZ wages are at par with non-zone
wages (Varma, Prasad and Krishna, 2010, p326).

 

Conclusion

This essay has dealt briefly into a few contentious issues that arise with the establishment
of SEZs in India. With significant employment not being generated, and with no
real rise in national exports has taken place, the rationale of this
establishment is called into question. The issue remains volatile, as was seen
in the case of Nandigram, where the conflict continued to simmer after the
government scrapped its plans to establish the SEZ there (Dohrmann, 2008, p76).

However, governments are unlikely to give up on establishing SEZs, and it is imperative that laws
are amended in order to make trade and investment flourish without disempowering
the people who are displaced or the workforce in SEZs. The Land Acquisition Act
of 1894 need to be looked into, and a transparent rehabilitation law needs to
be put in place (Dohrmann, 2008, p79). In fact, the people need to be made
stakeholders in the progress of the nation. Failure to do so may further prove
former Indian Prime Minister VP Singh correct in his assessment of the SEZ
policy of India, when he said (Dohrmann, 2008, p1), “the current promotion of
SEZs is unjust”, and that it acts as a “trigger for massive social unrest,
which may even take the form of armed struggle.”

__________________________________________________________________________________

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