Cash cows

Oct 12th 2006 | DELHI
From The Economist print edition

They worked in China. But will India's zones boost investment, or just
divert it?
Reuters
IT RESEMBLES the rows that have dogged every step taken by the
two-year-old government led by Manmohan Singh, India's prime minister.
The government's economic reformists, of whom he himself is the most
distinguished, promote a liberalising measure that will help boost
investment, fix India's lousy infrastructure and create jobs. They find
themselves howled down by a coalition of their Communist allies,
leftists in Mr Singh's own Congress party and other activists, who
accuse them of being anti-poor. The latest confrontation, however, over
the development of Special Economic Zones (SEZs), is different. This
time the criticism comes not just from the usual suspects but also from
some of the reformists, many economists and even some leading
industrialists.

The idea is simple enough: SEZs are enclaves with streamlined
procedures, tax breaks and good infrastructure that will lure investors
in export-oriented industries. Many developing countries, including
China, have used them successfully. They are not even new in India. In
2000 eight existing “export processing zones”, the first of which dated
from 1965, were converted into SEZs. But in February India's Parliament
finalised a new SEZ law, offering even more enticements. There has since
been the bureaucratic equivalent of a gold rush. Companies, including
most of India's most famous firms, have filed more than 400 applications
to set up SEZs, and 212 have been approved.

Banging the drum for India as an investment destination in London this
week, Mr Singh and his commerce minister, Kamal Nath, were able to point
to the SEZs as evidence of India's new openness. Mr Nath's ministry
hopes they will attract more than $5 billion in foreign direct
investment by the end of 2007—a huge amount for India by historic
standards (see chart). They are also intended to fix India's
“infrastructure deficit” of pot-holed roads, clogged ports and
intermittent power. The government hopes that with the incentives
available in SEZs, the private sector will make a big contribution
towards the $320 billion-worth of investment in infrastructure that
India is looking for in the next five years.

That is a laudable enough aim. But the SEZs are under fire on many
fronts. Politically, the most sensitive charge, and the one that will
probably lead to some change in policy, is that farmers are being forced
to sell their land and lose their occupations, and that state
governments and developers are profiteering. Sonia Gandhi, Congress's
leader, says that agricultural land normally should not be used for
SEZs. But under India's constitution land is an issue for state
governments, not the centre.

Many of the SEZs mooted may simply be property deals. Developers hope to
acquire cheap land, put in a minimum of infrastructure and sell it. Only
35% of the land area of a SEZ must be used for production. Even the
central bank, the Reserve Bank, seems to have suspicions, classifying
loans to SEZs as “real-estate” lending, which makes them relatively
expensive.

Even some investors planning to manufacture in a SEZ think the terms too
generous. They include a five-year holiday on profits tax, and exemption
from import and excise duties and from some licensing requirements.
Rahul Bajaj, chairman of Bajaj Auto, a maker of two- and three-wheeled
vehicles, argues that “any rational businessman would conclude he is
better off being in a SEZ.” Since, to qualify for the benefits, a
manufacturer in a SEZ need only be a net earner of foreign exchange over
a five-year period, rather than exclusively an exporter, firms such as
his can use a SEZ to supply some of their domestic market.

The fear of many economists—including some in the Ministry of Finance—is
that rather than promoting new business, the SEZs will merely attract
investment that would have been made anyway. Instead of finding fresh
sources of money for its infrastructure, India would thereby have made
things worse by depriving itself of tax revenue. Raghuram Rajan, chief
economist at the IMF, expresses concern that India, with its big fiscal
deficit, can ill afford this loss. Earlier this year the finance
ministry put it at 1,750 billion rupees ($38.3 billion) by 2011. The
commerce ministry counters with its own forecast that the SEZs will
generate additional revenues of 440 billion rupees.

One of the big differences between India's SEZs and China's is in size.
Although Reliance Industries, India's biggest private-sector company, is
planning enormous, town-sized, SEZs near Mumbai and in Haryana, near
Delhi, most of the others are tiny. The minimum area for a
“multi-product” SEZ is 1,000 hectares (3.9 square miles), for a
“product-specific” zone, it is 100 hectares, and for information
technology, biotechnology and jewellery, just ten hectares. By
comparison, Shenzhen, biggest and most famous of China's original SEZs,
covers 126 square miles. That scale was a huge factor in its initial
success— along with the presence, just over the border in Hong Kong, of
labour-intensive manufacturers wanting to lower their costs. Enjoying
neither of these advantages, India's smaller SEZs may do more for their
promoters than for India.
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