SEZs: Bumpy road to economic prosperity?

Vipin Agarwal

Certainly, SEZs are not the only route to achieving superlative economic
growth. There are many risk factors relating to the business model and
their success in the Indian context.

When China wanted to experiment with economic liberalisation, it decided
to set up four special economic zones (SEZs), referred to as
"laboratories" for testing out the economic model, in 1979. China reaped
large benefits from the laboratories and attracted large chunks of
foreign direct investment (FDI).

India, despite having been much more advanced and liberal in its
economic outlook vis-à-vis China, is only now adopting the SEZ model.
The process of liberalisation in India began in 1991, and 15 years later
we are trying to emulate the experiments of growth on a larger scale.
Thankfully, the initiative to increase public expenditure for
infrastructural development resulted in turning the cycle of economy,
proving the merit of Keynesian model.

Experience with SEZs

Of the four laboratories set up in China, Shenzhen was successful. Korea
achieved success from Masan between 1974 and 1979, though the growth was
followed by a flattening curve.

Historically, SEZs have resulted in spurts of economic growth, which
then flatten out to normal levels with time, save some exceptions like
Shenzhen. In fact, experiments by Russia and North Korea have not
resulted in anything exciting in terms of propelling economic growth.

The Indian experience with the SEZs has fallen short of expectations.
The key to success lies in creating at least one Shenzhen and gaining
more insights from it .

Shenzhen's development story has spanned over two decades; today it is a
modern city of four million people (from a population base of 20,000)
with per capita income of $4000. The process of development passed
through periods of modest growth, and the continuous focus on revising
strategies to achieve the targets is one of the key reasons for its
success.

The local administrative authority of Shenzhen promoted industries with
advanced technology and attracted the attention of well-known global
companies. Their constant focus on improving higher value addition
through investments into the region resulted in establishing sizeable
and significant capacities. For instance, today Shenzhen produces more
than 10 per cent of world production for certain category of products.
The local authorities continuously offered incentives, provided
facilities and improved the infrastructure to attract investors.

India has announced over 150 SEZs; the number may go up to 300. The
Finance Ministry has put the potential loss to revenue in excess of Rs
1,00,000 crore, whereas the Commerce Ministry projects the possibility
of increasing GDP to double digits through the SEZ route.

If one were to draw a comparison to the Modigliani and Miller model
illustrating the dividend neutrality to valuation of an organisation,
then the notional computations of non-realisation of revenue cash flows
from the trade/ventures of SEZ is more appropriate for academic
discussions than any real loss of cash flow to the country's fiscal
balance.

On the contrary, one Shenzhen can bring India FDI in excess of $20
billion with per capita income touching $5,000. This means India can
become debt-free, with surpluses on its balance of payments.

The risks

However, there are several risk factors associated with the proposed SEZ
initiative. They are: Number of SEZs announced is very high compared to
the international experience, probable ratio of success and the size of
investments to be committed in each SEZ.

In many cases, the credentials of the developers are not so good as to
enable economic financial closure, nor do they show pronounced
organisational capabilities of leading high-impact business entities.

The euphoria of SEZs has created disorder in the real-estate market and
this has been attracting speculative investor interest. This is where
the RBI has expressed serious concern.

The period of gestation in the development of infrastructure, attracting
industry and investments into the SEZ would take a minimum of five
years. This would expose the SEZs to cost and time overruns and
continuous revisions in the economics of the business plan.

SEZs are becoming vehicles for domestic industries to shift their export
segments and this could nullify the advantage of incremental growth in
country's exports.

The economics of SEZs may not hold great comparative advantages for an
investor vis-a-vis the domestic tariff area with due incentives for
exports. In Shenzhen, too, the land costs surged after a point of time,
forcing a number of industries to re-examine their strategies for
shifting base.

Key aspects

From the uniqueness of business advantage point of view, accessibility
to inexpensive human resources would be a key advantage for a global
player wanting to shift capacities to an Indian SEZ. However, in terms
of technology, except in IT, SEZs would have to depend on imports, like
Shenzhen, which, as a strategy, ensured high-value-added technologies
space in the SEZ. The regulatory guidelines have incidentally not
addressed any such aspect and this may lead to SEZs becoming logistics
hubs rather than real value-creators resulting in a incrementally higher
gross domestic product.

The role of local authorities managing the SEZ becomes one of the key
aspects for attaining success.

As per the SEZ Act, a public limited company would be floated to act as
the SEZ Authority for specified areas, with the Development Commissioner
as one of the members of the board. Although the constitution of SEZ
Authorities would be identical, the level of efficient functioning of
these bodies would become a crucial benchmark in the success or failure
of the SEZ.

Shenzhen has become a model to a number of economists and politicians.
The policy of SEZs will earn dividends if we are successful in creating
at least one Shenzhen. However, this requires focus and concentration of
energies. Certainly, SEZ is not the only route to achieving superlative
economic growth, as perceived by many sections of the society. There are
a number of risk factors associated with the business model and the
probable factors for success or failure of SEZs in India as well.

(The author is a Vice-President with Bharti Airtel. The views expressed
are personal.)

http://www.thehindubusinessline.com/2006/10/18/stories/2006101800241000.htm