Al Jazeera on India's SEZs

Al Jazeera has a quality video piece on its website that looks at SEZs, with a particular focus on Maharashtra. It includes (Maharashtra-based) interviews with academics on both sides of the SEZ issue. The report is fairly critical on issues relating to forcible land-acquisition.

Taxation and SEZs

Provisions in India' new Direct Tax Code could serious affect SEZs. It would drastically reduce the value of the concessions that currently help attract investments into SEZs. Tax breaks would henceforth be based on investment rather than profit levels. Existing SEZs are to be grandfathered, as will (apparently) units operating within SEZs before April 2010.

A couple aspects of how this state of affairs has come about are striking. The first is the ability of the Finance Ministry to exercise authority in ways that significantly undercut initiatives in other policy domains. The FM has always exercised outsized influence, but in the context of a fiscal crisis, and with a stalwart minister at the helm, it is doing so more vigorously and with less regard for the interministerial consequences.

V Balakrishnan, CFO, Infosys was quoted as saying that the lack of clarity in the relationship between the tax code and the SEZ policy 'creates uncertainty for any investments to come into SEZ. But he also saw a larger pattern of incoherence at work: "When the SEZ act came into force in 2005, the government proudly proclaimed that the three pillars of fiscal incentives, regulatory freedom and a supportive infrastructure would make the new policy a success. Today—the very same government has proposed a tax policy that takes the fiscal incentive pillar away. Without which, there will be nothing special about Special Economic Zones.

A change to the applicable tax regime also raises the question of what will happen to SEZs still in the process of acquiring land -- will these too be grandfathered? Or will only some of them, based on a discretionary waiver system, for which state-level approval would also be required? If some form of the latter arises, this will fuel further speculation about favouritism and rent-seeking -- a, perhaps, unintended consequence of thepolicy shift

Loans to SEZs to Qualify as 'Infrastructure' Lending

It has been decided by the Government of India that henceforth SEZs -- both firms that develop, operate and maintain SEZs, as well as firms that operate business units within them -- should be able to borrow on more commercially advantageous terms. Rather than being classified as real-estate lending, financing to these firms would be considered 'infrastructure,' thus attracting a lower-rate of interest and requiring borrowers to meet fewer qualifying conditions.

This is, in one sense, a valid reclassification. The public purpose provision within the Land Acquisition Act, formerly associated with large infrastructure projects, has been redefined to include commercial projects in which economic activity would be spurred; so why not see such projects as infrastructure when it comes to financing?

One very good reason is the element of risk involved. There is in general greater likelihood of a commercial real-estate developer (which is what many SEZ promoters are) becoming overextended due to perverse incentives related to moral hazard than would be the case with large traditional infrastructure projects where the public purpose was more apparent -- if not completely uncontested -- and therefore the implicit guarantee by the state and its agencies more meaningful in determining the associated risk premium.

A quote from the Economic Times coverage of the decision included this statement:

'LB Singhal, director general, Export Promotion Council for EoUs and SEZs said: “We had taken up this issue with the ministry of finance and the ministry of commerce. The matter was before the empowered group of ministers headed by finance minister Pranab Mukherjee, which had decided that SEZ should be treated as infrastructure.” '

The decision-making process is presented in this account (by an IAS officer whose job it is to promote the interests, and address the concerns, of business-people) as one in which both formal procedural requirements were met and substantive deliberation took place. Viewed differently, the process involved a longstanding policy conclusion, reached by a group of Mandarins, supported by experts in planning for financial contingency -- that is, both Finance Ministry and RBI officials -- being overturned in an overtly political forum in which tortured logic, and a vague nod to the difficulties associated with today's tight global credit markets, substitutes for rational debate. The ability of any EGoM -- particularly the leading figure on each -- to make these kinds of decisions makes this avatar of committee-based cabinet government an important institutional innovation, which India will end up either celebrating as a boon to efficiency, or lamenting as the further entrenchment of patronage politics.

Is it a North-South Issue?

This may well just be coincidence, but none of the six states to have passed SEZ Acts are in South India. They are Haryana, Gujarat, West Bengal, Maharashtra, Madhya Pradesh, and (just recently, in August 2009) Punjab. Here we have east, north, central, west, just not south. Any reason? It is especially puzzling because the states listed above are for the most part better-off or at least more industrialized states (with the exception of MP), and so are the South Indian states. One would not ordinarily expect the southern States to be fall into a category with (implying shared behaviour with) the likes of Orissa, Bihar, Rajasthan, Chhatisgarh, Jharkhand, and the always imperiled northeastern states. How many non-Southern states will have to pass SEZ Acts before it becomes statistically anomalous that the generally reform oriented states of Karnataka, Tamil Nadu and Andhra Pradesh have not taken legislative action?

The Indian Model?

It is fair to say that India has encountered a wide range of challenges in trying to establish SEZs -- not just the deadly violence in Nandigram and elsewhere, but also the the regulatory kinks that continue to need ironing out, the over-ambitious plans that have had to be shelved, and the difficulty of determining whether marginal gains in terms of investment, trade, growth or employment can be attributed to the SEZ phenomenon.

For this reason it may strike some as odd that India has now become an exporter of SEZ expertise. India has agreed to assist Nepal's fledgling government to establish one in a series of planned SEZs, in Birgunj. It is not clear whether the Nepalese authorities are fully cognizant that they may receive an Indian knock-off of a Chinese original. The Indian approach to SEZs -- particularly their limited size, large number, and relatively unplanned nature -- is at variance with many aspects of normal international practice.

Officers of the Government of India also raised the need for Bangladesh to construct new SEZs, presumably with technical assistance from India. This was communicated in the process of conducting the Sixth Joint Working Group Meeting on Trade between the two countries' officials. Quite apart from the oddness of India, which is in fervid pursuit of foreign investment, seeking to promote investment destinations outside India, there is also the matter of Bangladesh's PM having called on Indian industrialists to relocate their operations to existing Bangladeshi SEZs to avoid political troubles of the sort found across the border in Nandigram and Singur.

Note also that the Government of India is not the only channel through which India's experience with SEZ promotion and operation is being disseminated abroad. Through firms that develop and operate SEZs, provide consulting services, or bundle inward investments for SEZ promoters, India's increasingly outward-oriented business culture is finding a receptive audience fort their ideas on how to structure and maintain an SEZ.