SEZs in India :A

Quantitative Assessment of Costs and Benefits

Aradhna Aggarwal
Associate Professor Department of Business Economics University of Delhi Consultant : ICRIER aradhna.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)

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 Infrastructure Good Governance Location-specific advantages

Earning foreign exchange

Promotion of EOI

EOI is promoted through

Three channels

Domestic producers:
1. 2. Independent producers Insertion into GVCs (Small firms) Seller driven Buyer driven

MNCs Intra-firm trade

Clustering

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
1. 2. 3. 4. 5. 6. Foreign exchange Employment generation Employment for Females Skill Upgradation FDI Tech. transfers and creation 1. 2. 3. 4.

Indirect
Indirect employment Investment Skill spillovers Technology spillovers

1. Ind. growth 2. Productive Diversification 3. Human development 4. 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
2007
2008 2009 Total

Cumulative exports
30222.68
98535.43 174526.5 303284.6

Net foreign exchange

14573.6
52190.82 94265.64 161030.1

Direct tax liab

2113.3
6349.5 10911.2 19373.9

Indirect tax loss

Net benefits

Employ on account of productive act.

90668.05
295606.3 523579.5 909853.8

In direct employment

28479.8
40452.2 43536.0 112468

2178.7
3094.6 3330.5 8603.8

7601.623
34009.09 64547.84 106158.6

290026.7
578771.7 828331.5 1697130

Tax losses and benefits generated as proportion of incremental investment

Tax losses as % of actual investment 2007 2008 2009 Average Benefits generated

8.58 11.81

15.20325 42.51136

14.24 12.16

64.54784 46.16

Net benefits if no additional investment after 2009

Net benefits
7601.623 34009.09 64547.84 48899.05 39294.63 194352.23

Direct tax loss (Rs. Cr)

2007 2008 2009 2010 2011 Total 2113.3 6349.5 10911.1 8034.4 5911.6 33320.0

Indirect tax loss (Rs.Cr)

2178.7047 3094.5933 3330.504 763.2405 138.771 9505.8

Benefits under the diversion hypothesis (Rs. Crore)

Tax loss as Total Tax % to actual I loss Benefits as % (which is the including to actual I same as in the notional Table 7) IT sector taxes 4291.977 9444.098 14241.67 27977.75 11.41 27.13 40.93 29.7 8.58 11.81 14.24 12.16

Benefits net of the IT sector benefits

2007 2008 2009 Total

5703.198 21707.13 40934.7 68345.03

Dynamic gains from SEZs (Rs. Cr)

Additional output Corporate Indirect Salary total tax Employment (No.) Direct tax tax tax Collection collection collection collection

2007 64385.58 1287.712 4225.652 7532.868 5150.847 16902.61 30131.47 443.5265 1435.528 2520.337 6882.085 22563.79 40184.68 321927 1056413 1883217

2008
211282.6 2009 376643.4

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

National Contribution to exports, employment

Regional development Contribution to employment, Income generation Ancilliary industrial activities Most notable : SEEPZ, CSEZ, Kandla, Noida At the sector level significant contribution to technology transfer, spill overs and development of Local entrepreneureship : Gems and Jewellery, Electronics, SW, rubber gloves

Human development and Poverty

Technology Transfers, creation. And Spillovers limited Skill formation : Industrial Training, improvement in skill, Better prospects outside. 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

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 status
SEZ Nokia, Tamil Nadu: Status commenced commercial production Inaugurated by the PM Commences operation in November 2006 Units being set up Investment US$ 100 Million Employment (No.) Direct : 2800 Indirect : 10000 35000* by May 2007 3000* (2500 training) under

Quark City, Chandigarh: Flextronix in Tamilnadu

$ 0.5 billion FDI* $100 million

Motorola and Foxconn, Tamilnadu Apache SEZ (Adidas Group), Andhra Pradesh Divvys Labs, Andhra Pradesh Rajiv Gandhi Technology Park, Chandigarh Brandix Apparel SEZ, Andhra Pradesh
*Expected

$200 million*

5000* by Dec. 2007

Construction started

$50 million*

25,000*

Commenced operations

NA

8000* by April 2007

Construction started

NA

5000* by June 2007 (500 under training) 26000* by March 2007

Advanced stage construction

of

$100 million*

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.