Special Economic Zone

PREPARED FOR

Prof. Mridula Goel PGDM, Faculty Member Jaipuria Institute of Management, Lucknow PREPARED BY

Prateek Shrivastav Student, JIML

7 December, 2007 Jaipuria Institute of Management, Lucknow

INTRODUCTION India was one of the first in Asia to recognize the effectiveness of the Export Processing Zone (EPZ) model in promoting exports, with Asia’s first EPZ set up in Kandla in 1965. With a view to overcome the shortcomings experienced on account of the multiplicity of controls and clearances; absence of world-class infrastructure, and an unstable fiscal regime and with a view to attract larger foreign investments in India, the Special Economic Zones (SEZs) Policy was announced in April 2000. A Special Economic Zone (SEZ) is a geographical region that has economic laws that are more liberal than a country's typical economic laws. The category 'SEZ' covers a broad range of more specific zone types, including Free Trade Zones (FTZ), Export Processing Zones (EPZ), Free Zones (FZ), Industrial Estates (IE), Free Ports, Urban Enterprise Zones and others. The most successful Special Economic Zone is in China, Shenzhen that has been developed from a small village into a city with a population over 10 million within 20 years. Following the Chinese examples, SEZ have been established in several countries, including India. According to World Bank estimates, as of 2007 there are more than 3,000 projects taking place in SEZs in 120 countries worldwide. SEZs have been implemented using a variety of institutional structures across the world ranging from fully public (government operator, government developer, government regulator) to 'fully' private (private operator, private developer, public regulator). In many cases, public sector operators and developers act as quasigovernment agencies. SEZs are often developed under a Public-Private-Partnership arrangement, in which the public sector provides some level of support to enable a private sector developer to obtain a reasonable rate of return on the project.

MAIN OBJECTIVES OF THE SEZ ACT: (a) Generation of additional economic activity (b) Promotion of exports of goods and services; (c) Promotion of investment from domestic and foreign sources; (d) Creation of employment opportunities; (e) Development of infrastructure facilities;

APPROVAL MECHANISM AND ADMINISTRATIVE SET UP OF SEZS Under the Act, SEZ could be set up either jointly or severally by the Central Government, State Government, or any person (including a private or public limited company, partnership or proprietorship): for manufacture of goods; or • • •

for rendering services; or for both manufacturing of goods and for rendering services; or As a Free Trade and Warehousing Zone.

Approval mechanism

The developer submits the proposal for establishment of SEZ to the concerned State Government. The State Government has to forward the proposal with its recommendation within 45 days from the date of receipt of such proposal to the Board of Approval. The applicant also has the option to submit the proposal directly to the Board of Approval. The Board of Approval has been constituted by the Central Government in exercise of the powers conferred under the SEZ Act. All the decisions are taken in the Board of Approval by consensus. The Board of Approval has 19 Members. Its constitution is as follows:

Administrative set up The functioning of the SEZs is governed by a three tier administrative set up: • •

•

The Board of Approval is the apex body and is headed by the Secretary, Department of Commerce. The Approval Committee at the Zone level deals with approval of units in the SEZs and other related issues. Once an SEZ has been approved by the Board of Approval and Central Government has notified the area of the SEZ, units are allowed to be set up in the SEZ. All the proposals for setting up of units in the SEZ are approved at the Zone level by the Approval Committee consisting of Development Commissioner, Customs Authorities and representatives of State Government. All post approval clearances including grant of importer-exporter code number, change in the name of the company or implementing agency; broad banding diversification, etc. are given at the Zone level by the Development Commissioner. The performance of the SEZ units are periodically monitored by the Approval Committee and units are liable for penal action under the provision of Foreign Trade (Development and Regulation) Act, in case of violation of the conditions of the approval..

Consequent upon the SEZ Rules, 263 companies had received formal approvals to set up SEZs, and another 169 had been granted in-principle clearance by the government.

INCENTIVE/ FACILITIES TO SEZ ENTERPRISES:

Operational advantages: 

Sectoral restrictions on manufacturing sector inapplicable within SEZ

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All SEZ activities on self certification basis

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Single window clearance

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Inter unit transfer of goods permitted

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No routine customs examination of export and import cargo

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Forward looking labour laws under consideration

Fiscal advantages: 

100% FDI for manufacturing units operating inside SEZs through automatic approval route in almost every sector.

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100% profit repatriation facility from export earnings

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permission to sell within Domestic Tariff Area (DTA) and an exemption from a Special Addition Duty (SAD) subject to the company having a positive Net Foreign Exchange Position (NFEP)

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supplies from DTAs to be treated as exports while those from SEZs to DTAs to be treated as imports

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investments in SEZ treated as infrastructure development and eligible for exemption

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local inputs at reduced cost without the excise, VAT and other levies of India

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duty free import of materials for construction, capital goods and goods required for O&M

Customs and Excise: •

SEZ units may import or procure from the domestic sources, duty free, all their requirements of capital goods, raw materials, consumables, spares, packing materials, office equipment, DG sets etc. for implementation of their project in the Zone without any license or specific approval.

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Duty free import/domestic procurement of goods for setting up of SEZ units.

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Goods imported/procured locally duty free could be utilized over the approval period of 5 years.

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Domestic sales by SEZ units will now be exempt from SAD.

Domestic sale of finished products, by-products on payment of applicable Custom duty.

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Domestic sale rejects and waste and scrap on payment of applicable Custom duty on the transaction value.

Income tax •

Physical export benefit

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100% IT exemption (10A) for first 5 years and 50% for 2 years thereafter.

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Reinvestment allowance to the extend of 50% of ploughed back profits

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Carry forward of losses

Foreign Direct Investment: •

100% foreign direct investment is under the automatic route is allowed in manufacturing sector in SEZ units except arms and ammunition, explosive, atomic substance, narcotics and hazardous chemicals, distillation and brewing of alcoholic drinks and cigarettes , cigars and manufactured tobacco substitutes.

•

No cap on foreign investments for SSI reserved items.

Banking / Insurance/External Commercial Borrowings •

Setting up Off-shore Banking Units allowed in SEZs. OBU’s allowed 100% Income Tax exemption on profit for 3 years and 50 % for next two years.

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External commercial borrowings by units up to $ 500 million a year allowed without any maturity restrictions.

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Freedom to bring in export proceeds without any time limit.

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Flexibility to keep 100% of export proceeds in EEFC account. Freedom to make overseas investment from it.

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Commodity hedging permitted.

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Exemption from interest rate surcharge on import finance.

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SEZ units allowed to ‘write-off’ unrealized export bills.

Service Tax: •

Exemption from Service Tax to SEZ units

Environment: •

SEZs permitted to have non-polluting industries in IT and facilities like golf courses, desalination plants, hotels and non-polluting service industries in the Coastal Regulation Zone area

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Exemption from public hearing under Environment Impact Assessment Notification

Companies Act:

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Enhanced limit of Rs. 2.4 crores per annum allowed for managerial remuneration

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Agreement to opening of Regional office of Registrar of Companies in SEZs.

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Exemption from requirement of domicile in India for 12 months prior to appointment as Director.

Drugs and Cosmetics: •

Exemption from port restriction under Drugs & Cosmetics Rules.

Sub-Contracting/Contract Farming •

SEZ units may sub-contract part of production or production process through units in the Domestic Tariff Area or through other EOU/SEZ units

•

SEZ units may also sub-contract part of their production process abroad.

Agriculture/Horticulture processing SEZ units allowed to provide inputs and equipments to contract farmers in DTA to promote production of goods as per the requirement of importing countries.

SEZs in INDIA The policy provides for setting up of SEZs in the public, private, joint sector or by State Governments. It was also envisaged that some of the existing Export Processing Zones would be converted into Special Economic Zones. Accordingly, the Government has converted Export Processing zones located at: SEEPZ Special Economic Zone, Mumbai Kandla Special Economic Zone, Kachchh Cochin Special Economic Zone, Cochin Visakhapatnam Special Economic Zone, Visakhapatnam Falta Special Economic Zone, Kolkata Surat Special Economic Zone, Surat Indore Special Economic Zone (Multi-product), Indore Jaipur Special Economic Zone (Gems and Jewellery), Jaipur

SEZs and ECONOMIC GROWTH OF INDIA Most developing countries in the world have recognized the importance of facilitating international trade for the sustained growth of the economy and increased contribution to the GDP of the nation. As part of its continuing commitment to liberalization, the Government of India has also, since the last decade, adopted a multi-pronged approach to promote foreign investment in India. The Government of India has pushed ahead with secondgeneration reforms and has made several policy changes to achieve this objective.

SEZ Layout:

The SEZ policy was first introduced in India in April 2000, as a part of the Export-Import (“EXIM”) policy of India. SEZ can be sector specific or multi product sez. It helps in the development of infrastructure of the area around the SEZ, provides employment to people, and makes the exports more viable. All this will helps the country's products to become more competitive vis-a-vis providing all round development of region.

Exports from the functioning SEZs during the last three years are as under: Year

Value (Rs. Crore)

2003-2004 2004-2005 2005-2006 2006-07

13,854 18,314 22 840 34,787

Projected exports from all SEZs for 2007-08:

Growth Rate ( over previous year ) 39% 32% 24.7 52.3% Rs. 67088 crores

Current investment and employment: o o

Investment: Employment:

Rs. 43123 crores 35053 persons

Expected investment and employment (by December 2009): o o

Investment: Employment:

Rs. 2,59,159 crores 17,43,530 additional jobs

Expected investment and employment if 341 formal approvals becomes operational: o o

Investment: Rs. 3,00,000 crores Employment: 4 million additional jobs

Investment of the order of Rs.100,000 crores including FDI of US $ 5 – 6 billion is expected by the end of December 2007. Private investment by entrepreneurs in these SEZs established prior to the SEZ Act is of the order of over Rs. 5661 crore. The benefits derived from multiplier effect of the investments and additional economic activity in the SEZs and the employment generated thus will far outweigh the tax exemptions and the losses on account of land acquisition. Stability in fiscal concession is absolutely essential to ensure credibility of Government intensions. Special Economic Zone (SEZ) seems to be the hottest business to get into. At last count, 263 companies had received formal approvals to set up SEZs, and another 169 had been granted in-principle clearance by the government. Reliance Industries is pumping in Rs 30,000 crore into two SEZs in Maharashtra and another Rs 40,000 crore into a third in Haryana; DLF is investing over Rs 31,000 crore in four units in Amritsar, Ambala, Ludhiana and Gurgaon; and the DS group has a Rs 12,000-crore plan for two SEZs in Haryana and Himachal Pradesh. Others such as Bharat Forge, Videocon, Suzlon, etc., are investing over Rs 1,000 crore each in SEZs in places such as Pune and Mangalore.

Together, they hope to buy, develop and lease out over 300,000 hectares of land. These SEZs will house factories, IT parks, office space, warehouses, residential apartments and malls. A few may morph into cities. All that will call for a cumulative investment of Rs. 3,30,000 crore (based on a bare minimum of Rs 138 per sq. ft needed to buy and develop the land). Some, like infrastructure consulting firm Feedback Ventures, put the figure at Rs. 5,50,000 crore. That is the equivalent of pumping 10-17 per cent of India’s GDP into one grand realty development plan: corporate India’s biggest investment rush, at least on paper.

Performance of Existing SEZs (INR Crores)

PROBLEMS POSED BY SEZs I. Loss of Tax Revenue One of the issues raised by the opponents of SEZs is that they will result in the loss of Tax Revenues. However, if the tax exemptions are available only to export income, the hit on the exchequer will be minimized as most of the exemptions that have been listed exist in some form or the other. Eventually, as India moves towards a low duty structure, the exemptions will not actually mater since the differential will be minimal. The move to a central inland duty structure under GST will also help tax revenues. But, in the absence of both these enabling policy decisions, the above mentioned tax exemptions will definitely make conducting business in a SEZ a simple matter.

II. Land Acquisition Land acquisition has emerged as the most prominent operational problem in the setting up of SEZs. it not only has a financial impact but also has social repercussions. The landowner is typically a farmer. The other dependents on the land include landless laborers who work for the farmers. An agricultural based economic sty should be undertaken before acquiring any land. Only barren or single-crop land should be used for the SEZ development. 1. One-time compensation The landowner can be paid the prevailing market price up-front. This is not preferred because farmers, usually being illiterate are not used to such large amounts of money. Besides, such a payment method also makes it necessary for the developer to incur a substantial cash outflow upfront. 2. Equity ownership in the SEZ project Farmers can be given an equity holding in the Special Purpose Vehicle (SPV) that is developing the SEZ project. The farmers will get a part of the return earned by the SPV. Yet, the returns may not be sufficient compensation to the landowners. 3. Providing jobs as compensation The SEZ developer can offer a job to a member of the affected family in the SEZ or in an area close to the residence. the inherent problem in this solution is that of matching the skills of the family with that of the job offered. 4. Annuity-based payment depending on price of land Here, the farmer will be paid a price as an annuity for a fixed period of time, say 15 years. The amount of the annuity can be decided based on the prevailing market rates. 5. Annuity-based payment depending on productivity of the land In this method, the average annual income of the farmer can be calculated by using various factors like the kind of crop grown, the area of the land, and the total produce of the land. This income of the farmer from the land is then assumed to be till perpetuity and the money is then given as an annuity for a fixed number of years.

III. SEZs Turning into a Game for Real Estate Players The tax exemption structure mentioned hitherto does not provide any incentives for development of the social infrastructure apart from the duty exemption on capital goods. All real estate development will have to be done at market rates of financing. Infrastructure status will not be available to avail of low cost financing. Financing is not available at the land acquisition stage. As there is no tax exemption for non export oriented activities, the incentive to develop townships and other social infrastructure is not there. Since the sale of nay real estate unit in the SEZ is prohibited, there seems o be limited avenues for recovering excessive investment in the real estate space. The developers will seek to maximize the processing area and develop enabling infrastructure like roads, ports, etc, since such investment will receive infrastructure status and enable him to avail low cost financing. India desperately needs such infrastructure investment and this SEZ policy will policy will provide a fillip to such efforts.

Unfortunately, many SEZ builders see SEZ more as a grand realty development opportunity than as an infrastructure business — buy, build, sell. That model may bring profits in the short to medium term, but is unlikely to help the nation’s objectives of investment and export promotion. On the contrary, they could wreck India’s SEZ dreams by increasing competition and affecting the profitability of the serious players. They may also leave investors with bitter experiences or may simply unproductively lock up land. “Large numbers of SEZs will limit the success of all zones,” observes a Feedback report. It believes that only a few zones near metros will be successful. The rest will be a drain. Analysts predict that “only 25 per cent of the projects will see the light of the day.” Yet, in spite of all the negatives, we would hope that the issues will be addressed through formal policy amendments and SEZ will be a concept that’s lasts.

INDIA’S SEZs Vs CHINA’S SEZs SEZ has been one of the key reasons for the huge FDI that China has managed to attract so far. The concept of SEZ is fundamental model of China FDI model, where it developed SEZ on a focused manner. This is to be remembered that, this did not happen overnight and it has taken 25 years for China to become what it is today. The incentives offered in Indian SEZs are in no less than those in China. From duty-free imports and tax holidays to freedom from cumbersome Custom procedures, the SEZs' facilities match those in China. Hence, theoretically at least, India's SEZs should be no less attractive to foreign investors as the Chinese versions. But reality paints a different picture. Conceptually, EPZs and SEZs are different — while the former is an industrial estate, the latter is an industrial township. The scopes of SEZs are much wider and their linkages with the domestic economy stronger.Hence, merely switching from EPZs to SEZs, without undertaking the required structural changes, do not guarantee success. This is to be remembered that, China’s resounding success with the SEZ model of economic development, did not happen overnight and it has taken 25 years for China to become what it is today. There are five SEZs in China. Of these, four — Shenzhen, Xiamen, Shantou and Zhuhai — were founded 20 years back and the fifth, Hainan, was set up in 1988. Following are some of the reasons of China success with SEZ.  Size: Each SEZ is well over 1,000 hectares, the minimum recommended area. In India, the EPZs

converted into SEZs are not even a third of this.  Strong domestic market: In China, about 50 per cent of SEZ sales are to the domestic market. Though

India has a large domestic market, it has failed to project this to lure SEZ investors. The reason: Policy impediments to sales in the domestic market. While in China the thrust of SEZs has been to attract foreign investments and modern technology, in India the emphasis has been on exports. In 2001, the share of the five SEZs in the country's total exports was 10.4 per cent. In contrast, the of Indian SEZs in 2001-02 was a little over 4 per cent of the total exports.  Decentralisation of power: In China. Provincial and local authorities were made partners and

stakeholders, by delegating to them powers to approve foreign investment. The SEZ authorities in China can approve foreign investment proposals up to $30 million. In India, only State governments are allowed to set up SEZs and the powers for foreign investment approvals are vested with the Development Commissioners, who are the representatives of the Central Government.  Flexible Labour Laws: The hire-and-fire policy in SEZs has been one of the biggest attractions for

foreign investors in China. The new labour law consists of 107 articles, but none of these is more than one paragraph.

All jobs are on labour contract basis, which stand terminated upon the expiry of the terms, which can be fixed/flexible or for a specific job. In contrast, the labour policy in India is worker, rather than investment, oriented. Other features which have contributed to the success of SEZs in China: Unique location, investment friendly attitudes towards non-resident Chinese, attractive incentive packages, liberal Custom procedures. In sum, the fundamental objectives for setting up SEZs and their role in the national economy are different in the two countries. The impending need is buoyancy in foreign investments, which would automatically catapult exports. Thus it is to be remembered that, China’s resounding success with the SEZ model of economic development, did not happen overnight and it has taken 25 years for China to become what it is today.

Fact sheet on Special Economic Zones (As on 29th August 2007)