SEZs in India :A Quantitative Assessment of Costs and

Benefits

Aradhna Aggarwal Associate Professor

Department of Business EconomicsUniversity of Delhi

Consultant : ICRIERaradhna.aggarwal@gmail.com

Contents

• The Rationale

• Benefits and costs: Theoretical approaches

• Net Benefits: A quantitative assessment

• Benefits and costs : Qualitative analysis

• Conclusion

Why SEZs?

Two approaches

Orthodox Approach ( neo classical)Heterodox approach

(New institutional theories)

Earning foreign exchange

Promotion of EOI

SEZs offer relaxed tax and custom regime and offset anti-export bias in

import substituting regime

Offer good I climate in export oriented regime tax incentives :

Modern InfrastructureGood Governance

Location-specific advantages

EOI is promoted through…

Domestic producers: 1. Independent producers2. Insertion into GVCs

(Small firms) Seller drivenBuyer driven

MNCs Intra-firm trade Clustering

Three channels

Promoting manufacturing is important in India because…

• Service-sector driven growth. Employment generation potential is limited.

• The share of manufacturing remains almost constant at 16-17%.

• Evidence suggests that employment growth in the formal sector declined.

• Agriculture contributes less than 20% but over 60% people are dependent on agriculture and allied activities.

• A case study of Faizabad : 5 families multiplied to 300 families over time, cultivable land remains 1100 acres. No “break even” in many cases. Villagers are looking for alternative employment opportunities.

• There is need to improve investment climate to promote manufacturing but resources limited.

• Evidence suggests that zones can play an important role in attracting investment and promoting exports and industrialisation.

Benefits to the economy: Theoretical approaches

• 1. Orthodox Approach (Neo classical): • to offset anti-export bias in a heavily regulated economy :• always welfare reducing

• 2. Cost benefit approach (accounting method) :Warr, 1989• SEZs have both costs and benefits.• Their contribution depends on whether measurable costs are less than measurable

benefits. • Recognised indirect benefits in terms of income generated • These arise from backward and forward linkages but argued that they are limited.

• 3. Heterodox approach (Johansson 1994)• Underscored the importance of indirect effects through spillovers and

demonstrations.• Overall effects are difficult to measure

• Aggarwal (2007) : Spillovers also take place when • Zones’ entrepreneurs interact with the rest of the economy entrepreneurs in

various forums.• Zone entrepreneurs set up production units outside the zones.

Benefits : The Eclectic approach

Direct Indirect

1. Foreign exchange2. Employment generation3. Employment for Females4. Skill Upgradation5. FDI6. Tech. transfers and creation

1. Indirect employment2. Investment3. Skill spillovers4. Technology spillovers

1. Ind. growth2. Productive Diversification3. Human development4. Revenue generation for govt.

Quantifiable : static :Foreign Ex earnings, Net value addition, I, employ,

Dynamic : Income generation

Non quantifiable : other direct and indirect effects

Costs • Quantifiable:

• 1. SEZ development cost : Not incurred by the government

• 2. Revenue loss (Tax and other investment incentives)

• 3. Operational costs

Other welfare costs : Non quantifiable

• Resource transfer from the domestic sector to SEZs with no net addition to economic activities ( relocation and substitution effect)

• Land Acquisition without adequate compensation

• Impoverishment of farmers

• Loss of agricultural land

• Misuse of land for real estate

• Regional disparities

• Unequal treatment

Net benefits

• NNB = (EXP+DTA+TAXGAIN)-IMP-RM-ELEC-ADMIN-TAX LOSS• Where • NNB: Net benefits from SEZs • EXP : foreign exchange earnings and• DTA : Domestic Tariff area Sales • TAXGAIN: Taxes collected on DTA sales• EXP+DTA+TAXGAIN: Total benefits

• IMP : imports • ELEC : the cost of public utilities (electricity, power and fuel)• RM : the cost of locally purchased inputs • TAX Direct and indirect ( only for SEZ developers) tax foregone• ADMIN: Administrative costs• IMP+ELEC+RM+TAX+ADMIN : total cost

Fundamental assumptions:

• The proposed SEZ investment in each of the three years will be Rs. 100,000 cr.

• The actual investment in each year will follow a three years’ time frame. In other words, realized investment in the first year will be 50% of the proposed investment in that year say, t. In the second (t+1) year, 30% and in the third (t+2) year , 20% of the investment proposed in the year “t” will be realized.

• Of the total investment, 7% is projected to occur in the FTWZ /power SEZs in each year. The remaining will be invested in other zones.

• The infrastructure development expenditure in new SEZs will be 60% of the total investment in the first year. In the second and the third year it will be 30% and 10%.

• The remaining investment termed “productive investment” is divided between the IT sector and other sectors in the proportion of 44% in the first year, 42% in the second year and 40% in the third year.

• We required several other conduct and performance related ratios which are based on the CMIE database of the export oriented sector. Data was extracted for the relevant industries.

Projections of static benefits : 2007-2009 (Rs. Cr)

Total infra

Cumulative exports

Net foreign exchange

Direct tax liab

Indirect tax loss Net benefits

Employ on account of productive act.

In direct employment

2007 28479.8 30222.68 14573.6 2113.3 2178.7 7601.623 90668.05 290026.7

2008 40452.2 98535.43 52190.82 6349.5 3094.6 34009.09 295606.3 578771.7

2009 43536.0 174526.5 94265.64 10911.2 3330.5 64547.84 523579.5 828331.5

Total 112468 303284.6 161030.1 19373.9 8603.8 106158.6 909853.8 1697130

Tax losses and benefits generated as proportion of incremental investment

Tax losses as % of actual investment

Benefits generated

20078.58 15.20325

200811.81 42.51136

200914.24 64.54784

Average12.16 46.16

Net benefits if no additional investment after 2009

Direct tax loss (Rs. Cr)

Indirect tax loss (Rs.Cr)

Net benefits

20072113.3 2178.7047 7601.623

20086349.5 3094.5933 34009.09

200910911.1 3330.504 64547.84

20108034.4 763.2405 48899.05

20115911.6 138.771 39294.63

Total33320.0 9505.8 194352.23

Benefits under the diversion hypothesis (Rs. Crore)

Benefits net of the IT sector benefits

Total Tax loss

including the notional

IT sector taxes

Benefits as % to actual

I

Tax loss as % to actual I(which is the

same as in Table 7)

2007 5703.198 4291.977 11.41 8.58

2008 21707.13 9444.098 27.13 11.81

2009 40934.7 14241.67 40.93 14.24

Total 68345.03 27977.75 29.7 12.16

Dynamic gains from SEZs (Rs. Cr)

Additional output

CorporateDirect tax collection

Indirect tax

collection

Salary tax

collection

total tax Collection

Employment (No.)

200764385.58 1287.712 5150.847 443.5265 6882.085 321927

2008211282.6 4225.652 16902.61 1435.528 22563.79 1056413

2009376643.4 7532.868 30131.47 2520.337 40184.68 1883217

Contribution of EPZs to Industrial growth/diversification : A qualitative analysis

At the sector level significant contribution to technology transfer, spill overs and development of Local entrepreneureship : Gems and Jewellery, Electronics, SW, rubber gloves

Regional developmentContribution to employment,

Income generationAncilliary industrial activities

Most notable : SEEPZ, CSEZ, Kandla, Noida

NationalContribution

to exports, employment

Human development and Poverty

Remunerative employment for people with low Education level: : comparable wages and Better working conditions, satisfaction levels are higher Living conditions improved

after joining the EPZs

Skill formation : Industrial Training, improvement in skill,

Better prospects outside.

TechnologyTransfers,

creation. And Spillovers limited

SEZ Act provides a major thrust

• 1. A well balanced package of incentives, infrastructure, governance is offered.

• Should tax incentives be offered: • Yes, Our survey-based study shows that

• The most important ingredient in any SEZ policy is :Tax incentives

• Three reasons: • Export obligations, attachment with GVC, no location choice.

• Second most important factor: good governance : custom rules and single window clearance.

• Third: infrastructure : within zones: electricity and water; outside zones: transport, roads, ports and airports

• Fourth : location. If good external infrastructure, this is not important. The argument that they should be set up only near the ports is not sustainable.

Current statusSEZ Status Investment Employment (No.)

Nokia, Tamil Nadu: commenced commercial production

US$ 100 Million Direct : 2800Indirect : 10000

Quark City, Chandigarh:

Inaugurated by the PM

$ 0.5 billion FDI* 35000* by May 2007

Flextronix in Tamilnadu

Commences operation in November 2006

$100 million 3000* (2500 under training)

Motorola and Foxconn, Tamilnadu

Units being set up $200 million* 5000* by Dec. 2007

Apache SEZ (Adidas Group), Andhra Pradesh

Construction started $50 million* 25,000*

Divvy’s Labs, Andhra Pradesh 

Commenced operations

NA 8000* by April 2007

Rajiv Gandhi Technology Park, Chandigarh

Construction started NA 5000* by June 2007 (500 under training)

Brandix Apparel SEZ, Andhra Pradesh

Advanced stage of construction

$100 million* 26000* by March 2007

*Expected

Recent patterns

1. Formal approvals : 234 as on May 1, 2007

2. AP : 45, Maharashtra : 47, Tamilnadu : 25, Karnataka : 29, Haryana and Gujrat : 19 each, Kerala 10, UP 8. WB: 7,MP : 4

3. IT : 133, Electronic HW and SW : 16; 10 multi products; 12 Pharmaceuticals, 9 bio tech, over 11 textile

4. In principle approvals : 164

5. Notified as on 1st May 2007: 100

High tech industries that have come up due to SEZs: Electronics Manufacturing Services, Semiconductor, Aerospace,

Other industries benefited : Biotech, Pharmaceutical, automobile, textile.

Costs : A qualitative Analysis

• Relocation : Misplaced. but in the IT sector substitution effect is evident

• Land Acquisition : Needs serious research, should not be left to the private parties.

• Loss of agricultural land : Need to create “land bank” along the lines of TN.

• Impoverishment of farmers : Needs research. But sharp rise in land prices, Huge compensations, They must be offered specifically designed investment plans for these funds to ensure regular incomes. This may provide them security.

• Misuse of land for real estate : Need for exit policy and regular monitoring

• Uneven growth : misplaced

• Unequal treatment with exporters : Tax incentives to STPIs and EOUs.

• A large number of IT sector SEZs : Once STPI incentives restored, this issue will be addressed.

Conclusion

• SEZs can act as catalyst to industrial growth provided they are implemented effectively.

• Effective implementation of a policy that aims at giving shock to the economy requires mobilization of public opinion. People often approach such an issue initially with strong, emotionally laden feelings and opinions. It must be shaped and formed so that important decisions are taken without creating instability in the society.

• Four things are important :

• The government must slow down the process of giving approvals. This is important not only for social or political reasons but also due to economic realities.

• Legal institutions related to land acquisition ( including land acquisition modalities, compensation package and rehabilitation package) must be addressed.

• Introduce a performance based exit policy for SEZ developers

• Restore STPI and EOUs benefits

• Finally, the policy should be treated as transitory.