While SEZs have been thought of as a boon for Indian exports, this has changed in recent times. The decline of SEZs and falling exports has been cause for alarm. The Dollar Business looks at why SEZs have been dying, and how whether or not their selling to DTAs, at reduced rates, can once again recharge the economy.
Manisha Choudhari | January 2016 Issue | The Dollar Business
Night scene of Shenzhen special economic zone in ChinaChina’s unprecedented economic growth has always been a source of awe for the rest of the world. One of the main reasons for this rapid growth was the setting up of its special economic zones (SEZs) in early 1980s. And then, there was India. Despite India’s first special economic zone being set up in Kandla, Gujarat in 1965, the SEZ Act wasn’t put forth until four decades later. For uninitiated, SEZs are areas within a country that have different economic laws from the rest of the country i.e. they are areas with different foreign trade laws, tariffs and duties. In India, the ‘SEZ Act, 2005’ came into effect in early 2006, and provided simplification of procedures and a single window clearance in the setting up of units and of setting up SEZs, and on matters relating to central as well as state governments. SEZs contributes to nearly a fourth of the country’s overall exports. and are important because they generate employment, foreign exchange, and foreign direct investments.
SEZs in recent years have been plagued by a variety of problems, from land acquisition and environmental issues to policy lacunae. To top it, in 2011, the Finance Ministry decided to impose the minimum alternate tax (MAT) and dividend distribution tax (DDT) on SEZ units, citing a huge revenue loss from exempting SEZ units from these taxes, which led to a number of developers giving up their projects. But now, having realised that the removal of these taxes would mean increased investment in SEZs, the Commerce Ministry is pushing for the removal of those taxes.
But if policymakers wants to achieve the objective for which the SEZs were formed, they may have to start working fast. Though the policymakers aim at reducing the corporate tax rates from the current 30% to 25% (as announced in Union Budget 2015) in the next four years, they are also phasing out several deduction and exemptions enjoyed by SEZ units by FY2018. This, once again, means that developers will continue to shy from setting up units in SEZs given that there are no longer the tax exemptions they once used to enjoy; in addition to the fact that exports have been falling continuously over the last twelve months (as of November 2015). Perhaps this is the reason why, despite there being 327 notified SEZs in the country, only 202 are operational, spread across 16 states.
In fact, the decline in exports for 12 straight months is indication enough that SEZs are failing. One way of saving them (on top of giving a boost to the Indian economy) is by letting SEZs sell to DTAs at zero percent duty.
Under the FTP2004-09, SEZs were allowed to sell to DTAs, as long as the DTAs paid regular customs duties including the safeguard, anti-dumping (AD) and countervailing (CVD) duties. However, if a DTA unit can get raw material without paying import duty from a country that we have a FTA with, then why would the unit pay taxes and get the same from an SEZ? Interestingly, some officials at Commerce Ministry have now started pushing for the lowest import duty tax for DTAs buying from SEZs i.e. the same rate that it offers to countries it has FTAs with.
Of The 327 Notified Sezs Only 202 Are Operational Across 16 States
Today 87% of goods produced from SEZs are exported, as there is no incentive for DTAs to procure from a SEZ manufacturer. If the government allowed SEZs to ‘export’ to DTAs at preferential FTA defined rates or zero duty, we could possibly see more enthusiasm for taking up SEZ projects amongst large developers. This could also open up avenues for foreign producers to set up plants in Indian SEZs as it will give them access to both the large Indian domestic market as well as exports market, while leveraging the SEZ status for preferential import duties. For example, let us assume that there is a cocoa products major based out of Singapore who imports cocoa beans from Ghana, adds value to it in his Singapore base and exports cocoa powder/butter to India, for consumption in the domestic market. Since India and Singapore have an FTA this transaction attracts zero import duty. However, if this manufacturer had been based out of an SEZ in India, his product would have attracted a total import duty of about 53.543% if somebody from DTA would have wanted to source it, making his prices non-competitive. If India would have allowed export into DTAs at preferential duties this manufacturer would have every reason to set up a base in India and both export and sell to the DTAs.
Sales To Dta Areas Comprise Only 13% Of SEZ Revenues
DTA buyers would also prefer buying from an India based manufacturers as ideally transport costs will be much lower and they would not have to hedge their prices against currency fluctuations. One could argue, doesn’t the name SEZ itself mean that manufacturers here are given privileges that manufacturers in DTAs don’t receive because they are supposed to export and earn foreign exchange for the country? We agree and believe that SEZ based manufacturers be given the permission to sell in DTAs only when they are net foreign earners. That would keep our balance of trade in shape while at the same time allowing sales into DTAs would help us save precious foreign exchange. With SEZs essentially being infrastructure projects, which require significant investments in time and money by the developer, there are more than enough reasons to make SEZs more attractive for developers to invest in India. Additionally, this development will most certainly help grow the Make in India scheme, furthermore putting India in the limelight and in turn giving a boost to our GDP and the economy.
Given that selling to DTAs at FTA duty rates is not allowed currently, we are missing out on everything SEZs are expected to bring in – FDIs, jobs, infrastructure, technology as well as foreign exchange earnings. Allowing DTAs to import from SEZs at FTA rates will only do good to all.
With their immense contribution to the country’s GDP, FDI, exports and employment, SEZs set the tone of the rapid growth in early years. We need that momentum back in a slowing global economy. Let’s make SEZs special again.
“Before Reviving Exports We Need To Revive Manufacturing”
P. C. NambiarTDB: How successful have SEZs been for India?
P. C. Nambiar (PCN): First, compare the activity from 1965 to 2005 and then 2006 to 2014. Up to 2005, there was no comprehensive zone for SEZs. It was predominantly run by Central government of India. Until 2005, 18 SEZs were operational. As of now, in 2015, there are 202 operational SEZs.
Coming to whether or not the SEZs have been successful in the country let us look at the objectives of SEZ: To get investment, generate employment, and increase exports and get foreign exchange. At the end of 2005, the total investment in SEZs was Rs.4,093 crore. By 2015, it became Rs.3,83,000 crore. From Rs.4,093 crore to Rs.3,83,000 crore is a quantum jump. Therefore, that much investment has come into an SEZ area. So, in terms of investment, yes, the SEZs were successful.
When you invest money, the ultimate result is employment generation. Up to 2005, total number of people working in SEZ was 1,34,000. By 2015, it is over 15,00,000 – that is over ten times. So, in terms of employment also the SEZs have been substantially successful.
Now, coming to exports. By end of March 2006, total exports from SEZs was Rs.22,840 crore. By March 2015, the export was worth Rs.4,64,000 crore. Exports have grown multifold. DTA sales i.e. from SEZ to domestic market have never exceeded 13%. Predominantly, whatever goods and services are manufactured from SEZs have been for exports – 87% has been exported. And, whenever you sell anything from SEZ to DTA, you are paying full custom duty, so it is as good as import.
TDB: What are the challenges faced by these special zones?
PCN: SEZ is an infrastructure project. That means, in a barren land, you create a township, or an industrial estate. First of all, there are few land availabilities. Land is a state government subject. After getting land, you need the state government’s ‘No Objection Certificate’, approval from the Central government, planning approval, environmental clearance, etc. The whole process takes 4-5 years in order to create an SEZ. After the development of SEZ, you start giving plots to proposed units. It may take 1-2 years to make the buildings as planned. So, you cannot start exports of goods and services for at least 5-7 years.
Look at the SEZ Act, which was implemented in February 2006. From 2006 till today – in 9 years- so many amendments have been made. There is no single window clearance as per the SEZ Act. There is no priority given by any state government on SEZ approval. Prior to 2006, there was no comprehensive Act and regulations. But after the SEZ Act was implemented and rules were placed, they were never stable, and were always being amended. The government is not sure of what they want to do.
In SEZ Act, it was said that there will be upfront income tax exemption for the developer and the units. In 2010, MAT was implemented at 18.5% plus education cess. That is to be recovered or adjusted within ten years of your tax liability. No one will be able to really utilise this credit if taxable income is much lower than the tax which is paid – the MAT credit is higher than your tax liability when you become taxable.
The main hassle faced is that the government – state or central – has no idea about free zone development or operations. It depends on the fancy of the individual minister or bureaucrat. They are changing everything without prior information. They are insensitive to the people who have put money to create social and industrial infrastructure, so developers are not investing money now. Out of 327 notified zones, only 202 are operational, as others are uncertain about the governments policies. The lack of clarity and sense of commitment from the central and state governments is a problem. The entire system in the country has to be changed. The policies are very good on the document, but implementation and outcomes really needs to be fixed.
TDB: What steps can be taken to revive exports from SEZs, considering exports between FY2013 and FY2014 fell by 6% from these zones?
PCN: Exports are not the problem. It is manufacturing. When you manufacture, only then can you export. You are not able to put up a factory because all the clearances and approvals take minimum three years, and then you have to get your building plan approved as well. SEZ is a project where you can provide manufacturing capabilities. Out of 202 operational SEZs, 114 are IT/ITeS, and around 80-89 are manufacturing SEZs. You need to see how many manufacturers are located in the SEZ, what is their capacity, what sector they are working in. The number of manufacturers in SEZ is substantially low. You cannot expect a quantum jump in export of merchandise goods. Before reviving exports, we have to revive manufacturing.
TDB: Do you think that reducing taxes/duties on products sold from SEZs to DTAs will help goin forward?
PCN: Selling from SEZ to DTA is import substitution. Import substitution is when instead of buying from outside, you buy from India. If the material is not supplied from SEZ, a DTA unit will import from some foreign country. If it imports from a foreign country, the unit pays forex, and maybe a lower rate of duty. By supplying from SEZ to DTA, exports are not increased, but import substitution will take place as such. Foreign exchange can be saved if you sell from SEZ to DTA, which will be beneficial. There is no restriction on selling from SEZ to DTA, but only 13% of total manufactured products go from SEZ to DTA.
Electronic hardware products are manufactured by SEZ. Those items, when sold in India, levy a certain duty. If you buy it from a foreign country, you don’t pay a duty at all. Such items should be allowed to be sold from SEZ to DTA at low duty – not as a general policy, but some items like that can be identified; items for which we have FTAs with other countries. Because in terms of quantum, it is high. Second, it is labour-oriented – there will be more job opportunities when SEZs start to sell to DTAs. We are in the process of identifying products which are covered by FTA in various countries with India – electronic hardware manufacturing, chemicals, apparels, non conventional energy sources (like solar panels), processed foods, etc. All of these items that are covered by FTAs can be allowed for sale from Indian SEZs to DTAs at a reduced duty. This will help improve productivity in India’s SEZs, and will save us on valuable foreign exchange.
TDB: Given that SEZs account for 25% of India’s exports, is this sluggish growth cause for alarm? What can the government do to help?
PCN: Today, 30% of exports from India come from SEZs. When exports from all over the country are falling, then so will the exports from SEZs. The problem is that the product is not competitive. Even today, you have the inverted tax structure. You are still paying taxes and duties. Even for getting material imported from a foreign country, you need a delivery order from a shipping company, on which state governments are levying additional duty. Everything is taxable in this country – and that tax is non-refundable – and so, is adding to the cost. Unless your product is competitive enough, you are not able to export the product. Therefore, a total study on export of goods has to be done and studied on the three-tier levels of government – local, state, and central. Stern and strong decisions have to be taken, and then implemented. The GST also hasn’t come through, so you cannot expect much from political parties. It is the collective responsibility of the manufacturer, the seller, the trader, the government, and logistics company to make exports competitive. All have to work together in partnership. But exports have never been a priority in this country. Additionally, there is no particular logistics support for SEZ exports – the airports are choked and so are the sea ports and shipping companies are charging whatever they want. Our products are not able to compete in the world market. It is not that we cannot manufacture, we can. It’s just that we cannot manufacture at the prices that others are selling at in other countries.
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