Can DESH do what SEZ can’t?
In February, the government announced its intention to abolish the Special Economic Zones (SEZ) law. Instead, they said they would replace it with something called the Enterprise and Service Center Development Act (DESH). And with the new legislation set to pass during the current parliamentary monsoon session, we thought we might examine why SEZs in India have not lived up to their promised potential.
This is what our software exports were worth in fiscal year 2021 (FY21). Now, obviously, you can attribute that to a whole host of things. Visionary entrepreneurs, exceptionally talented IT employees and a large English-speaking population. But there is something else too – the amount of incentives and the tax benefits made available to IT businesses through Special Economic Zones â designated areas with special economic regulations to help businesses thrive.
But before we get too far ahead, we need to explain what these SEZs actually do and how they came about.
Let’s go back to 1965 when the small town of Gandhidham in Gujarat became India’s (and even Asia’s) first SEZ. The government then carved out a small plot of land to attract manufacturing plants with one key lure: tax breaks. The area became known as the Kandla Export Processing Zone (EPZ). And as the Kandla experience matured, other EPZs began to appear across the country.
The government’s goal was simple: boost the country’s export engine and earn money while creating more job opportunities. But progress was still slow. Until the 1990s, when the government looked at the success of SEZs in China and decided to step up a gear. A key example came from Shenzhen â a SEZ born in the 1980s. transformed the region from a humble fishing village to an industrial giant that was home to over 90,000 foreign companies and attracted over $300 billion in foreign investment.
Thus, the Indian government passed the SEZ Act in 2005 to give a boost to its export plans. He was telling businesses that they would get a 100% income tax exemption on all export earnings for the first 5 years. A 50% exemption for the next 5 years. And the option to reinvest the profits into what’s called the SEZ reinvestment reserve for another 5 years (essentially reinvesting the money into upgrading machinery and such) and getting tax exemptions again .
And the results look promising at first glance. From a measly 19 SEZ in 2005, we now have over 250 SEZ today. At the same time, the quantum of exports from these SEZs also soared â from just â¹22,840 crore to almost â¹7,60,000 crore.
But if you peel back the layers, you’ll find that things aren’t all right.
You see, the purpose of creating SEZs was to push manufacturing and promote massive industries producing things like steel, pharmaceuticals, and textiles. But more than 60% of the country’s SEZs are actually in IT, ITeS electronic hardware and related spaces. Basically the software and its ilk! And while that’s definitely a good thing for IT, SEZs served a distinct purpose: to give manufacturing a boost.
But that plan never really took off.
Why? you ask.
Well, one of the main reasons is space constraints.
Just to give you some context, when the Shenzhen SEZ was created, it covered an area of ââ327 km2 (which was later expanded). But in India, the average size of an SEZ is about 1 km2. There are no mega SEZs. And this is partly related to the problems of acquiring these large tracts of land needed for SEZs. In the end, these small SEZs simply did not have the right facilities and high-quality infrastructure needed by manufacturers.
Yet another issue, as they say in the real estate industry, was âlocation, location and locationâ. You see, some research suggests that SEZ locations were chosen for the benefit of local politicians who speculated in real estate. Thus, in many cases, the SEZs were not located according to the economic potential of the region. Instead, they were chosen to maximize the revenue of a small coterie of corrupt politicians. And as a result, the development has not spilled over to neighboring towns either.
And over the years, companies began to ignore SEZs because the tax incentives were no longer attractive. Businesses enjoyed similar benefits elsewhere as well. Add to that the fact that SEZs tend to be on the periphery, with labor issues often resulting in inflated wages. Businesses had to spend more just to locate here.
While 378 SEZs received final approval, only 268 of them are operational. The others have gone through a denotification process. That means the developers just raised their hands and said, “Listen, we don’t want to go ahead with the SEZ after all. Units don’t work very well and we don’t have money to keep things running. And even if you consider the SEZs that are fully operational, you will see that there is a lot of vacant space. In fact, 10 crore square feet of space which is valued at â¹30,000 crore.
And that’s what the government is trying to change now by introducing something called the DESH Bill.
So how is it going to be different?
Well, it’s too early to tell. But from what little we know, it seems the government isn’t just trying to push exports this time around. He wants companies to manufacture for India and the world. Thus, even if a company focused solely on manufacturing for domestic needs, it would be entitled to benefits if it moved to a “development center”. Second, while most decisions in the area of ââSEZs were attributable to the central government, the DESH bill will likely also seek greater input from state governments. In this way, there is more cooperation between the state and the center. Third, they intend to make the DESH bill WTO compliant.
What does that mean?
Well, you see, the World Trade Organization (WTO) wants to make sure that all countries engaged in international trade follow the rules. This means that a government cannot offer excessive tax breaks and subsidize production, just to ship these cheap goods and services around the world. With the new legislation, the Indian government hopes to provide just the right amount of incentive to avoid the wrath of the WTO.
And yes, this obviously does not solve all the problems with SEZs that we talked about earlier. But the government hopes the lessons learned from pursuing the SEZ program will help it write better rules this time around, so India can prosper.
Will this actually happen?
We will have to wait and see.