Zoned out

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SEZs, which came in with much hope, have lost the plot. Can they revive?

Zoned out
In India, special economic zones (SEZs) can be traced back to 2005 when a Parliamentary act enabled little islands of economic excellence to incorporate growth engines that would potentially, not just generate jobs for millions of aspiring Indians but also enlarge the country’s export basket and strengthen forex reserves.

Their origins, however, go back further — to Kandla in Gujarat when India’s first export processing zone was set up in 1965, back in the bad old days of the licence permit raj when professional businessmen themselves were considered none-too-respectable.

Set up with much fanfare and drama, as an idea for triggering economic growth, SEZs could hardly be flawed. But since then, they have been through a roller coaster ride; one of extreme highs to the current lows where they are wallowing at the bottom of the barrel. Now, with a new government ostensibly committed to boosting manufacturing, hope lies at the beginning, rather than end of the tunnel.

Much water has flown under the SEZ bridge since its early salad days when investments poured in, jobs were created with the fillip received from the services sector, especially the IT/ITeS industry, and exports soared. Sadly, these halcyon days lasted for about half-a-decade. Since then the road has been down hill.

Consider the following:

n In 2006, Reliance had drawn up mega plans for SEZs in Haryana and Mumbai. The Reliance Haryana SEZ has been converted into a township and no longer remains a SEZ. The Haryana government had earlier this year abandoned its ambitious plan to develop a 25,000-acre SEZ with Reliance in Gurgaon and Jhajjar districts. It has since decided to take back about 1,380 acre given to the company.

n The land, which was originally acquired by the Haryana State Industrial Development Corporation (HSIDC) will now be utilised to develop a global city project under the Delhi Mumbai Industrial Corridor Project (DMIC), according to media reports. The township is now planned as a high-value manufacturing area with an international exhibition and convention centre and skill development centre, among others.

n In the case of the Navi Mumbai SEZ, a senior company official, who did not wanted to be quoted said, “The project has continued to linger as promises made by the central and the state governments have not been fulfilled. It has reduced the interest of units to participate in the multi product IT SEZ. All the IT benefits were diluted. Even the new government assured some benefits for the SEZs in the budget, but nothing was announced and it has now been passed by the Lok Sabha”.

n Some of the SEZs planned by the GMR and the GVK groups in south India have proved to be non-starters.

These examples help to reveal that somewhere enroute, the concept of SEZs and objectives behind the very enactment of the act seemed to have floundered in the face of internecine battles between the ministry of commerce and industry on one side and the finance ministry on the other. The differential attitude of the states and their own priorities in promoting and adopting the concept of SEZs has not helped.

The issue became starker, ever since the UPA government went back on its sovereign promise of a 10-year tax holiday for SEZ developers and units and imposed instead a minimum alternate tax (MAT) and dividend distribution tax (DDT) on unsuspecting developers.

Two things happened; thanks to this inconsistency, global investors knew where not to put their money, while for those who had already pitched in, the nightmare had just begun.

For Rakesh Talwar, marketing head of NSL Infratech, which established an IT SEZ over 25 acres, the reintroduction of MAT in 2012 has been a setback. “The profit margins shrank,’’ he explains.

Concurs S Srinath, senior advisor, tax and regulatory services, KPMG India: “The imposition of MAT and DDT became a big dampener for SEZs. But, there are a few other issues, including lack of clarity of the rules and regulations that resulted in the SEZ concept losing its aura.’’ He should know.

Over the past three or more years, SEZ developers lobbied hard with the government to rethink imposition of MAT and DDT. It also pleaded for clarity on several other issues. But the then UPA government, already reeling under a current account deficit (CAD) pressure, was in no mood to oblige. The policy paralysis that characterised the UPA-II regime did not help matters, nor did the vaguely attempted changes in the SEZ rules.

There are other anomalies as well. According to officials, the Maharashtra government still doesn’t have a SEZ Act like Tamil Nadu, Rajasthan or Gujarat, which deprives the economic zones to take advantage of local-level fiscal benefits. “We have the funds available with us. We are just waiting for clarity to emerge on the new policies before we proceed with the project,” the official, who does want to be named, points out.

Is there a way to get back SEZs as growth engines or will they continue to stutter along? With a new government and a majority of its own, some hope has been rekindled. President Pranab Mukherjee in his address to the Parliament said SEZs would be made the ‘centres of growth’.

Union minister of state with independent charge for industry and commerce Nirmala Sitharaman has been vocal in her support for SEZs and the need to review existing policy. Officials in the commerce ministry too have been talking about impending changes in the soon-to-be-announced new foreign trade policy (FTP), which it is hoped, will help the cause of SEZs.

To be sure, not all is lost. Sitharaman told the Parliament in early July that within a span of eight years since the SEZ Act and rules were notified in February 2006, formal approvals were granted for setting up of 565 SEZs, out of which 388 were notified. At present, around 185 SEZs are exporting. Out of the total employment provided to 1,283,309 persons in SEZs as a whole, 1,148,605 were in incremental employment.

Physical exports from SEZs have increased from Rs 4,76,159 crore in 2012-13 to Rs 4,94,077 crore in 2013-14, registering a 4 per cent growth.

There has been an overall growth of export of 2,063 per cent over the past eight years (2005-06 — 2013-14). The total investments in SEZs till March 31, 2014, is Rs 2,96,663 crore, including Rs 2,73,379 crore in the newly notified SEZs, that were set up after the SEZ Act.

At the same time, Sitharaman conceded that the SEZ sector has seen a sharp slowdown because of an uncertain fiscal regime and global slowdown. “The government, on the basis of feedback and inputs from stakeholders on the policy and operational framework of SEZs scheme, periodically reviews the policy and operational framework of SEZs and takes necessary measures to facilitate speedy and effective implementation,” she said.

The optimism was infectious and word was out that certain policy changes might well be announced in the first NDA budget itself. However, finance minister Arun Jaitely stopped short of that, given the huge fiscal deficit monster that he has to tackle before letting go of cash through fiscal benefits to industries. While there was no mention of abolishing MAT or DDT, he did fairly hint at the government’s keenness to get SEZs out of their doldrums.

The key of course lies in reviving manufacturing itself. “We have to revive manufacturing growth,” Jaitley said, before going on to raise the FDI limit to 49 per cent from 26 per cent in defence manufacturing with full Indian management and control through the FIPB route. He also permitted the manufacturing units, which entered India through the automatic FDI route, to sell their products through retail including e-commerce platforms, without the need for any additional approval.

Agrees Nirav Kothary, head — industrial services, JLL India. “The industry has to learn to adjust to the new situation with MAT while making business plans. There is enough juice in the SEZ story for the industry, especially by way of excise and customs duty benefits, even though income-tax benefits were diminished through MAT. But, it is still positive for manufacturing in terms of exports,” he averred.

Kothary makes an important point. According to him, when the government initiated the move on SEZs in 2001, services as a sector was not even part of the SEZ plan and it was all about hardcore manufacturing. “Somewhere along the route, services made a back-door entry into SEZs. The entry actually gave a fillip to SEZs and generated jobs. But, soon it became a real estate game, at least in cities like Bangalore and Delhi.”

That in turn became a tussle between the commerce and finance ministries and resulted in MAT. “MAT affects SEZs only to an extent. But it was blown out of context, thereby creating a negative picture about these economic zones. This along with the Vodafone taxation issue and policy paralysis not only added to the picture of gloom, but also conveyed a wrong message to global investors,” he explained.

Others like BVR Mohan Reddy, executive chairman of Cyient, which has established an SEZ at Sarpavaram in Kakinada, Andhra Pradesh, in a five-acre area, believe MAT is okay if kept to 10 per cent. As per the initial act, it was zero per cent tax for the first five years. “The MAT during 2009-10 was about 10 per cent, during 2011-12 it increased to 18.5 per cent and with surcharge rounded off to 19 per cent. This is not allowing the companies to reinvest,” feels Reddy.

For instance, every effort is being made to equate goods and services under SEZs but there is a big disparity between the two when it comes to selling in India. While manufacturing units in SEZs can sell their goods to other entities in India and receive the charges in Indian currency, in the case of service SEZs, they have to collect in foreign currency.

“There are several SEZ units that offer services to large PSUs. It could be for high-end design or other technology-enabled service works. It is an open secret that PSUs want to keep their forex spend as low as possible in order not to attract the government’s ire. So, even where there is opportunity, service SEZs are unable to tap it. Where is the encouragement for growing the domestic industry,” Srinath queries. Good point.

While initially, both the industry and government were ignorant about this differentiation, it is now snowballing into a big legal hurdle, especially over the past one year. “If un-resolved, it may soon turn to be another big dampener for service SEZs at least,” Srinath pointed out, adding: “While captive SEZs do not face this problem, it creates complications for a true SEZ offering services to third parties. Such interpretation has been a problem and needs to be fixed at the earliest,” he added.

Another instance is the case of job works undertaken by units in SEZs. They import the raw material — it could be steel sheets or blanks used by gem & jewellery units — convert it into finished products through value addition and export them back. This process comes under the definition of manufacturing and is exempted from duties. But, the government also sees this as a “job work” and slaps service tax on them. “How on earth will the Indian entity explain to his foreign counterpart that the government levies a service tax of about 12 per cent, despite the unit functioning out of a SEZ,’’ Srinath observed.

According to him, the industry at large has never been averse to paying taxes. But, what they want is clarity on the tax that they have to pay. Such frequent changes and mis-interpretation hurts them. “The government has to send a clear message that the tax structures are for the long term, with a clearly indicated periodicity in force and that it will stand by what it means. If this is done, more than the quantum of money, it will help improve investor confidence to a very large extent,” says Srinath.

Sunil Rallan, president, Tamil Nadu Association for SEZ Infrastructure Developers (Tasid), the only federation in the country that has brought all SEZs operating in the state under one umbrella, emphasises the need for clarity. “The government has to simplify and rationalise procedures that are very complex and complicated. This has led to interpretations being different in different regions, depending on the assessing officers. This does not require any policy changes and can be implemented in two to four weeks. Once this is done, it will solve 30–40 per cent of the problems being faced by SEZs,” he argues.

According to him, building infrastructure for better access and transport of goods to and from SEZs, takes time. Announcing fiscal benefits are hard to come by, given the government’s precarious fiscal deficit scenario. “Let the government identify the low hanging fruits first and go about setting them right. Instead of waiting for six to eight months to do things at one go, which runs the risk of not happening due to the enormity of the task at hand, let it be delivered in phases,” he advises.

Soon after the new government took charge, Tasid had submitted a set of SEZ policy reforms for the manufacturing sector. “The government has taken it up positively. It has initiated a stakeholders’ meeting and sought inputs in order to make the reform process more pro-active. We have to wait for the outcome but have not seen anything in terms of delivery as such,” Rallan concluded.

Common sense says it is too early to expect delivery. A two-month-old government can hardly be expected to do that because policy changes take time. But, whichever the government in power, commerce ministers have always been vociferous in their support of the industry. It is quite another matter when they have to convince finance ministers to go with them. It remains to be seen how the Narendra Modi government is going to be different.

(With inputs from Krishna Mohan in Hyderabad & Vikas Srivastav in Mumbai)

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