Special Economic Zones (SEZs) are again in the news, but this time around, the controversy is over how an SEZ can cease to be one. Around the country, demands for 'de-notification' of SEZs have come up.

An enclosed piece of land becomes a legal entity - a Special Economic Zone - once a 'notification' is issued by the Central Government. The developer of the SEZ is entitled to various tax and customs benefits, but is bound by the prevailing SEZ rules for land use - a specified portion of the land can be used only for hosting export-oriented industrial units. If the government later 'de-notified' the SEZ, it would turn the land into holdings that the developer could freely use for real estate projects. However the SEZ Act, framed in 2005, did not visualize such an eventuality - it had no exit clause for SEZs.

De-notification is sought in two different contexts. One type of demand is from SEZ developers, who are queuing up at the Commerce Ministry to get a part or the whole of their land area 'de-notified'. DLF, a real estate company, has already obtained permission to scrap an IT SEZ near Delhi, and 6 other companies across the country have been allowed to reduce the size of their zones. But this is just the beginning; it is expected that many more promoters will follow the lead set by DLF, particularly if the Government does not bail them out by easing funding norms for SEZs and relaxing the timelines for making them operational.

Land for SEZs has in many cases been acquired by state governments at depressed prices using the coercive provisions of the Land Acquisition Law under the guise of 'public purpose' and transferred to private promoters. A recent example of this form of state intervention is the acquisition of 50 acres of prime land near Visakhapatnam by the Andhra Pradesh Industrial Infrastructure Corporation and its subsequent sale to Satyam Computers Limited at a throwaway price for setting up an IT SEZ. (Hindu Business Line, 18th Dec 2008) Developers stand to make windfall profits from the land in cases when the government subsequently revokes the SEZ status. However the government has not considered it important to address the question of restoring land to the original owners.

An entirely different voice for scrapping SEZs has been the widely popular people's movement in Goa that has been active for nearly two years now. The popularity of its cause has forced even the state government to demand that the 3 SEZs that have been 'notified' in Goa be scrapped. The central government, however, has maintained an unyielding stand for over a year, citing the lack of an exit clause in the SEZ Act. The lack of such a clause did not deter the government from finding ways to accede to the requests of private promoters. But the request of a state government representing popular sentiments has not been found equally compelling.

Past performance: a reality check

The first SEZs (under the SEZ Act) were notified in mid-2006, and by March 2008 there were 206 of these entities. (There were a few mainly government export promotion zones operational even earlier, but this article is concerned with the zones that have come up under the SEZ Act that was specifically crafted to attract private promoters.) How did these zones perform with respect to the stated objectives of exporting goods and services, bringing in foreign capital and creating employment? It is time for a reality check.

According to government figures for 2007-08, these 206 SEZs attracted a capital of Rs.69,000 crores including Rs.5400 crores of Foreign Direct Investment (FDI); they provided direct employment to 98,000 workers; and exported goods and services valued at Rs.5200 crores. (All figures rounded)

Most of these SEZs were in the IT/ITES sector, a sector that already enjoyed special tax and customs treatment and was rapidly expanding even before the SEZ Act came into being. If the SEZ policy was framed with a view to promoting investments and exports in manufacturing and services other than IT/ITES, as one was made to believe, then the relevant numbers look much worse.

Non-IT/ITES zones accounted for direct employment of only 32,000 workers, exports of Rs.1800 crores and FDI of Rs.3800 crores in 2007-08. To get some perspective on these numbers, these exports were less than 0.3 per cent of India's exports, and less than 4 per cent of total FDI inflows. India's need for employment generation was estimated by the ILO a few years ago to be at least 10 million jobs a year! The data for the next six months up to September 2008 show only a marginal increase of workers employed and capital deployed, though the number of SEZs had gone up sharply from 201 to 260. Against the backdrop of these numbers, it is obvious that the performance of the SEZs has not been in line with the stated policy goals so far.

The missing competitive advantage

The global economic crisis has most certainly hit exports and foreign investment flows and will have affected the prospects of SEZs. However, the figures above are for a period that predates the crisis and perhaps points to other problems with the SEZ policy.

The lack of economic activity in most SEZs leads to the suspicion that many promoters were incapable of attracting economic production units to their SEZs in the first place, and were merely betting on them as real estate assets and relying on loopholes in the law to realize their value at a later date. This suspicion is only reinforced by the number of real estate developers in the fray who have been advertising SEZs as their 'crown jewels' and collecting enormous sums from the market in public issues of shares.

A second issue that bears scrutiny is the lack of foreign direct investment (and interest) in the SEZs. The FDI inflow of about Rs.99,000 crores for 2007-08 was focused on goods and services for the domestic market, with the exception of IT and IT enabled services. FDI obviously looks at the competitive advantage of a country before investing. China today is the manufacturing hub of the US, having established itself over the past 25 years. Just as China displaced exports from Taiwan, Japan and Korea to the US, India would need to displace exports from China to the US in order to increase its own manufacturing exports to that country. The fierce competition with China in exports in today's tough environment is evident even in the case of traditional exports from India such as textiles and apparel. The question is, can India compete with China's specialization in cheap manufacture in areas other than its traditional exports?

The policy makers seem to operate on the premise that once India provides the infrastructure for manufacturing and a tax free regime, the availability of cheap labour and raw materials will secure India a competitive advantage. But all these have been available in China for some time. More importantly, China has also invested in skills and training of a large work force that mans its export factories; India is far behind in this respect (See this link for more). The evidence on the ground is that FDI recognizes India's specialisation in cheap IT and ITES alone as of now.

Persisting with folly

But even in this situation where the existing SEZs are unable to sustain themselves and looking up to the government for support and concessions, the central government continues to entertain new SEZ proposals. State governments are also not far behind, with coercive land acquisition activities in full swing.

In Karnataka, the state owned Karnataka Industrial Area Development Board (KIADB) has been acquiring land to turn the Mangalore SEZ from a petrochemicals zone to a larger multi-product zone in the face of strong opposition from local communities. In Andhra Pradesh, the government has been working closely with a private developer, acquiring a major portion of the land for the Kakinada SEZ using the Land Acquisition Act, and employing the police to evict farmers who have resisted handing over their lands to the developer. In both places, the affected people are using multiple means - courts, environmental regulatory bodies, political parties and public protests - to resist the state.

After all the debate and assurances on land acquisition and rehabilitation issues, the government has not moved an inch. Land Acquisition continues with the help of a law framed in 1894.

Time to take stock

The severe depression in the developed countries has put paid to any dreams of rapidly building up exports, least of all in non-traditional sectors. By all accounts, the depression is likely to persist at least for the next two years - so also will the drought in FDI in manufacturing and even IT/ITES services for export. There is clearly a situation where there are too may SEZs, particularly for IT/ITES, without any business. The farmers have already been evicted from the land; the fields lie barren without the promised factories and jobs.

With the prospects of massive unemployment in its export zones and the fear of civil unrest, China is embarking on a major program to direct production towards satisfying internal rural markets. The serious risks inherent in the paradigm of export based development are becoming clearer by the day. This is as good a time as any to take stock of India's SEZ policy.