In a recent appraisal report, the Income Tax Department noted certain irregular transactions in the Nirav Modi group companies – there was a difference in stock valuation of the group’s units in special economic zones (SEZs) to the tune of Rs 1,216 crore which hinted at unaccounted sales of imported diamonds.

On further probe, the Director-General of Income Tax (Investigations) found that in 2016-17, the SEZ units of the group in Surat diverted high-quality diamonds, which were imported for processing and were to be exported, to domestic markets for higher profits. And low quality diamonds were, in turn, exported to keep up appearances.

In light of the above and certain other issues like unutilised land, misused land, under-utilisation of capacity, etc, it pays to evaluate SEZ policies and the performance of units located within such SEZs.

Therefore, the decision to constitute a committee to suggest necessary changes to SEZ policies, as announced by Commerce and Industry Minister Suresh Prabhu comes at the right time.

As per the Special Economic Zones Act, 2005, while notifying an area as SEZ, the central government is to be guided by:

Generation of additional economic activity
Promotion of exports of goods and services
Promotion of investment from domestic and foreign sources
Creation of employment opportunities
Development of infrastructure facilities
Maintenance of sovereignty and integrity of India, the security of the state and friendly relations with foreign states

The list clearly states intent and according to a report by Scientific Research Publishing, SEZ policies and foreign direct investment (FDI) inflows share a significantly positive relationship. However, there is room for improvement at operational, monitoring and the performance levels.

Malini L Tantri, Assistant Professor at the Centre for Economic Studies and Policy, Institute for Social and Economic Change (ISEC) in her book titled Special Economic Zones in India - Policy, Performance and Prospects writes “… it is necessary to investigate how a policy is being implemented. Because, a police may fulfil the first oder (sic) condition, ie, clarity underlying a policy but there can be flaws at the implementation. This is specifically so, because a policy is framed by the Government but it is bureaucracy that implements at different levels.”

“Land claimed to be used for SEZ purposes by developers is at times misused,” a consultant specialising in indirect tax laws said. “For example, a developer will say that he’ll be developing 100 acres of land for SEZ purposes over a period of 5 years. But, he develops only 25 acres and uses the balance 75 acres for other purposes. At the expiry of 5 years, he files a plea, requesting the officer for an extension of time period to develop the remaining land. And since the officer has discretionary powers, he may allow this and the misuse may continue for further periods. There’s also a possibility that the remaining 75 acres is just left unused.”

He also highlighted another loophole relating to duty-free imports made for non-SEZ operations. Speaking of a scenario, wherein an SEZ unit imports certain machinery without payment of duty on the condition that such machinery will be used in the processing area for authorised operations, he said that in reality such machinery may be used for operations being carried out in non-processing area (ie, the area marked as non-SEZ area). While the SEZ rules state that movements from processing area to non-processing area are to be documented, it is not very easy to monitor circumventions of such rules.

The absence of monitoring mechanisms was also highlighted by the Comptroller and Auditor General of India (CAG) in their report on performance audit conducted in 2014. The report said “developers and unit holders were almost left unmonitored, in the absence of an internal audit set up. This posed a huge risk for revenue administration. The inadequacies in the performance appraisal system of SEZs, compounded by lack of internal audit, facilitated developers to misrepresent facts to the tune of Rs 1,150.06 crore, which remained undetected as there was no mechanism to cross verify the data given in the periodical reports with the original records.”

On the performance front, Tantri, in her book, notes that while the performance of SEZ units, in absolute terms, is promising, the policy has not proven to be effective in diversifying the country’s export basket and promoting a strong industrial base. She believes that a state should promote two or three product-based SEZs from the point of view of efficiency and cost. And the most important task which is to be undertaken in this regard is with respect to identification of each region’s comparative advantages in factor endowments and productions processes. This view draws support in theory also since exports, which are to be promoted from a region to attract FDI, should reflect the region’s comparative advantages or else it may result in under-utilisation of resources.

Lastly, it would do well to go back to roots and examine why India, impressed by the success of SEZs in China, adopted a similar policy in the first place.

The SEZ policies in China have been carefully drafted and patiently implemented over a few decades and while tax incentives offered to SEZs in India mirror those offered in China, it ought to be noted the intent behind creation of SEZs is much broader due to its relations with overall job creations, improvements in complementary infrastructural facilities like roadways, ports, telecommunication, etc.

According to a paper written by Chee Kian Long, a professor at the University of Nottingham, “…how the SEZ strategy fits into the overall growth strategy of a country may be important. In the case of China, the SEZs were envisioned as a gradual approach to liberalisation and the resulting success of some of the zones were used as political justification of a more liberal policy towards trade and FDI… the SEZ experience may help in the export-oriented growth by enabling an erstwhile closed economy to participate in the global trade and exploit its comparative advantages. The resulting development in infrastructure in human capital may then pave way for a broad-based growth… Thus, the manner by which SEZs are related to economic policy could be important and merits further exploration in future research.”

SEZs are supposed to drive the overall development of a country and not function merely as privileged pockets offering tax incentives. Therefore, it would do well if SEZ policies in India could be designed to fit into larger economic strategies.

Rishika Pardikar

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