Why only a few will make it

OMKAR GOSWAMI

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IMAGINE a country where power is available everywhere in great abundance. Where it needs just a simple permission to get all the electricity that you need to set up a factory. A country with excellent manufacturing infrastructure where you need to carry very little, if any, inventory of raw materials or finished goods. A country where the road transport and logistics networks are such that you don’t lose even a few hours of production. Where there are flexible labour laws. Where you don’t need multiple approvals from various listless government bodies to set up business. Where the direct and indirect tax rules are simple, the rates globally competitive, and the procedures are designed to facilitate the growth of business. By definition, such a country is so special in terms of the ease of doing business that will never need any Special Economic Zone (SEZ).

India is emphatically not such a country. Nor does one expect it to be in the near future. Thus, the argument that if we created a sufficient number of enclaves of infrastructural excellence such as SEZs, we could substantially increase investment, output of goods and services and employment. Detractors argue that even if successful, these would be at best a few tiny islands of development in a vast ocean of relative backwardness. But that’s an old, hollow argument, because it is better to at least have a few things that work than the egalitarianism of nothing working.

Factually, SEZs have come to stay in various parts of the world, and for exactly the reasons mentioned above. In 1974, there were around 80 SEZs across 30 countries generating barely $6 billion in exports and employing under a million people. Three decades later in 2004, there were over 3,000 SEZs in 120 countries exporting more than $600 billion and creating several million direct jobs.

India, too, has joined the SEZ bandwagon. The Government of India introduced the concept in 2000 Exim policy. After much deliberation between the Ministries of Commerce and Industry, and Finance, the Special Economic Zone Act, 2005 was passed in June 2005 – which came into force on 10 February 2006 with the notification of the SEZ Rules, 2006.

 

According to the act and its rules, SEZs can be promoted for manufacturing units as well as services companies. The basic criterion for setting up an SEZ is for the government to ascertain the availability of space and infrastructure support applied for and confirmed by the developer. The benchmarks are: A minimum of 1,000 hectares is required for multi-product SEZs; 100 hectares for services SEZs and sector-specific SEZs; and 10 hectares for gems and jewellery, biotech, software, electronics hardware and non-conventional energy.

Moreover, to apparently help develop some of the ‘backward’ states, the minimum land requirement has been eased to 200 hectares and 50 hectares respectively for multi-product and sector specific SEZs.

There have been applications galore, and a sizeable number of these have been okayed. As on end-December 2007, 404 SEZs were formally approved by the Board of Approval constituted under the SEZ Act, 2005. Of these, 193 have been notified. Another 165 cases have been approved ‘in principle’. Around 65% of the 193 notified SEZs are for IT and IT enabled services; and 15% for pharmaceuticals, textiles and multiproduct activities. Not surprisingly, more than half of the notified SEZs (55%) are to be located in the fast growing states of South India; 22% are in the West, 18% in the North, and only 4% in the East.

 

Despite popular as well as purely politically motivated protests in West Bengal, Orissa, Maharashtra and, more recently, in Goa, there has been no dearth of interest of developers to apply for SEZs. In substantial part, this has been induced by significant fiscal concessions. Any SEZ developer can get the benefit of:

* Tax deduction of all profits from the business of developing an SEZ, for any 10 consecutive years out of 15, from the date of notifying of the SEZ.

* Exemption of interest and capital gains to those who invest in SEZ development vehicles.

* No dividend distribution tax on dividends declared, distributed or paid on or after 1 April 2005 out of current income.

* Exemption from Minimum Alternate Tax (MAT) on income accruing or arising from 1 April 2005.

There’s more for those who move in to set up business in these SEZs. So long as an SEZ-based unit is a net foreign exchange earner, it can avail of extremely attractive tax breaks. On the direct tax front, companies having units in SEZs can get full tax deduction of 100% of their export profits for the first five years of starting commercial business, and 50% of export profits for the next five years. There are certain capital gains exemptions arising out of shifting assets from urban areas of SEZs, as well as exemption from MAT.

It is certain that a sizeable number of SEZ applications have been prompted by these significant fiscal concessions. It is also certain that a large number of notified or approved SEZ proposals will not translate to any facility worth the name. Today, for many, the situation is no different than an old fashioned ‘license grab’: lets get a bunch of guys together with some political connections; apply for a small to middling SEZ; get it approved and notified; and then see what value can be generated out of this state-approved piece of paper.

Yet it would be wrong to paint all potential SEZ developers with the same brush. There are several large corporate entities with an impeccable record for project execution and delivery who have lined up more than one large SEZ project. And most, if not all, of them can deliver high quality infrastructure more or less on schedule.

What then are the criteria for setting up a successful SEZ? I believe that six exacting conditions need to be simultaneously fulfilled for any multi-enterprise SEZs to succeed.

 

The first condition is scale. A multi-enterprise SEZ must have at least 5,000 hectares – preferably above 10,000 – to have a fair chance of success. I can’t see too many 1,000 hectare SEZs doing very well, unless they happen to be in spectacularly competitive locations.

The second condition is location. You can give all the concessions in the world, but you can’t expect an SEZ in Bastar to succeed. Almost by definition, an SEZ that stands any chance of success must be near major ports or airports, and have to be connected by world class infrastructure.

The third is to have really deep pockets. Any successful SEZ promoter must have the financial muscle to absorb large net cash outflows for the first six to seven years. He must first have enough cash to begin with, and second, the reputation to leverage three to four times that amount from banks and longer term lending institutions. And we aren’t talking small beer here.

The fourth condition for success is executing capability. The difference between a successful SEZ promoter and the many also-rans will lie in project execution skills – the capability to deliver world class infrastructure on or before schedule, and more or less on budget. There are not too many of this tribe in India for a 5,000 hectare to 10,000 hectare project.

The fifth requirement is high levels of political networking – not only with the big honcho ministers but also with local politicians and bureaucracy at all levels. SEZs need considerable government support at all levels from the panchayats upward, and for all possible contingencies. A successful promoter must have the stature, network and reputation for reciprocity to garner such support.

The sixth, and final, requirement is the ability to attract the best of the corporate world as marquee clients of an SEZ. Simply put, the promoter must have the imprimatur to call upon the best Indian and multinational companies to set up their units in his SEZ, and few should have the ability to refuse him – not just for what he offers but for who he is.

Only a few of those who have got approvals and notifications for their SEZs actually meet all of these six conditions. Thus, only a few will make it, and many won’t. Let’s hope we don’t have a serious fiscal scam before that occurs. For that will surely throw the baby out with the bathwater, which would be terrible. Because even half a dozen first-rate SEZs with best-in-class facilities and infrastructure will mean a great deal for growth.

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