labels: rex mathew, economy - general
Throwing the baby out with the SEZ bathwaternews
Rex Mathew
13 April 2007

Faced with strident opposition, the government has diluted the SEZ policy and may go even further in future. The government may be wasting its best opportunity to make domestic manufacturing globally competitive.

As often happens with not so well thought out government initiatives, the whole SEZ policy risks being pruned so heavily as to make it virtually ineffective. Even as the initial opposition to the policy was slowly dying down, the overzealousness of the West Bengal government to win back its popularity ratings in the aftermath of the Nandigram violence has dealt a body blow to an initiative, which, if implemented properly, could have changed the face of Indian manufacturing, and created millions of new jobs.

With various elections till the next general elections barely two years from now, it has become very difficult to be seen as pro-SEZ.

SEZ's are needed to help the manufacturing sector overcome infrastructure bottlenecks and become globally competitive. After 60 years of Independence, ideally the whole country should have had access to far superior infrastructure, than what it has today. But today, that would be asking for too much given the decades of neglect. Accordingly SEZs could have become a shortcut to creating pockets of growth.

The government's first mistake was to promote such zones with tax benefits as a primary incentive rather than better infrastructure. Even supporters of SEZs would accept that the tax breaks being offered were simply too liberal to be necessary. With the basic premise that only the inadequate infrastructure holding back domestic manufacturing in place, what was the need for pampering potential investors with tax breaks?

The liberal tax benefits attracted a lot of small developers, who came up with proposals to set up tiny single-product zones. Many of these proposals for tiny zones came from IT services and BPO companies, who flocked in to invest in these SEZs only protect their low-tax status for another decade or more. Ironically, a policy aimed at boosting the manufacturing sector became even more attractive to service sector companies who are already globally competitive in every respect. It is arguable whether many of these IT services giants really need the tax holidays they enjoy now, let alone another decade or more of nearly tax-free existence, that can only help them boost their market valuations, rather than acquire new competencies.

The government last week gave final clearance to 171 SEZ proposals, which had earlier received formal approvals. Of these, 83 projects, which have completed all the initial work including land acquisition, would be notified soon while the others would be notified as they complete all the formalities.

A vast majority of the proposals that have been cleared are small single-product zones which are being set up only for the tax breaks. Ironically, rather than spur new infrastructure creation, many of these proposed zones, will be a further drain on existing infrastructure as they are being located in already congested areas or the periphery of fast developing cities. Without adequate provisions for transport infrastructure and utilities like power and water, these zones would only worsen the strain on existing infrastructure in those cities.

The second mistake was to fix the minimum area to be set aside for industrial units within a zone to just 25 per cent of the total area. The remaining area was earmarked for "common facilities" - a euphemism for lucrative commercial areas like shopping and entertainment centres, schools, hospitals and residential spaces.

This has led to widespread perception that the SEZ policy is only a faint disguise to legalise land grabbing by influential developers for building premium residential townships, in the name of promoting industry. This has been rectified to some extent by increasing the minimum area for industrial units to 35 per cent, though the government should consider relaxing this condition on merits.

The decision to impose a ceiling of 5,000 hectares for all SEZ's is an even bigger mistake. State governments have been given the option to fix even lower ceilings. At least the Left-ruled states may opt for lower limits as the CPM had demanded a maximum ceiling of 2,000 hectares in its policy note to the government.

Fixing a ceiling for SEZ's runs contrary to the very idea of such zones. A special zone is most effective when it is large enough to contain the necessary infrastructure to meet the needs of industrial units taking up space.

If allowed, some of these zones could have become self-contained cities with their own transport network, airports, power stations and other utilities.

Such new development would have eased the pressure on the existing large cities to some extent. By limiting their scale, the government is forcing them to depend on the existing inadequate infrastructure to a large extent. This would considerably reduce their ability to attract new industrial units, especially large units that need larger land area.

True to form, the amendment to limit total area of SEZ's is ambiguous. It is not clear if the same developer would be prevented from building two projects adjacent to each other to overcome the ceiling on the size. There are reports that Reliance Industries is considering this route for its proposed Maha Mumbai SEZ and Haryana SEZ, which would have come up on 10,000 hectares each as per original plan.

It is not that SEZ developers are going to take over entire districts to build their special zones. All the 234 SEZ projects, which have so far received preliminary approvals, would collectively need only around 34,000 hectares of land, as per the government's own figures

That brings the whole issue of land acquisitions to a better perspective. It is not so difficult to find 34,000 hectares of suitable land for industry without causing as widespread displacement as feared. It would indeed be a difficult for SEZ developers to insist on setting up their projects on heavily inhabited fertile farmland, even though some developers have indeed been guilty of refusing to even consider other locations to avoid large scale displacement of farmers.

With some help from the government, developers can easily identify large tracts of less fertile or barren land, which are removed from heavily populated areas. However, only large self-contained SEZ's can survive in such less accessible locations. All they would need are good links to the highway and rail networks. The cost of building such links should not be an issue as the large number of industrial units in such projects would make them viable.

All that this country needs is a handful of such large self-contained zones, located in different parts of the country, to ease the burden of inadequate or non-existent infrastructure. By focussing on the number of zones rather than the size of zones in its SEZ policy, the government has been chasing the wrong vision.

When faced with trouble, the instinctive reaction of most governments is to wash their hands off as early as possible. After the Nandigram mess, the government has already announced that it would no longer play an active role in land acquisitions. This makes it even more difficult to set up large SEZ's, which require considerable government assistance to purchase large tracts of land.

Governments the world over use the doctrine of eminent domain to acquire private property in public interest. Both central and state governments have acquired large tracts of land in the past for PSU industrial units, many of which have become defunct now. In fact, the value of the land holdings of some of these PSU companies far exceeds their business valuations.

In the past, with television and the radio having been a government monopoly and the limited reach of print medium, such land acquisitions by the government could never have been challenged. Nor could one ever examine and if excess land was being acquired by PSUs.

Today those who are opposing SEZs argue that acquiring land for private industry is not necessarily a public benefit and hence eminent domain should not be invoked to forcibly acquire land. However, the counter view to this is that since the benefits of large SEZs to the general economy are well established and therefore is a matter of public interest.

A fear being voiced is that if a private developer were to succeed in acquiring land through direct negotiations with landowners, it is possible that some landowners may refuse to sell and block the entire project. The only way out in such cases would be acquisition by the government as a private developer cannot force a landowner to sell his holdings even if there is abundant public support for the project. The use of eminent domain may perhaps be justified for such projects, especially since their viability depends on availability of sufficient land being available contiguously.

It is unlikely that the whole controversy surrounding the SEZ policy would die down soon. The opponents of SEZs may now feel emboldened to try to force the government to dilute its policy and that would make larger projects even more unviable.

Finally, all that the policy may end up facilitating could be a handful of small projects, perhaps, promoted by service sector companies to enable them to extend their tax holidays. If that is how the SEZ policy finally end, , it would be only because of the government's lack of vision and complete absence of strategy and coordination to make a policy initiative successful.

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Throwing the baby out with the SEZ bathwater