DESH: Key to reviving dying SEZs?

In February this year, the Government of India announced that it would replace the Special Economic Zones (SEZ) Act, 2005, with the Development of Enterprise and Service Hubs (DESH) Act, to facilitate ‘Make in India’ and ‘Ease of doing business'.

SEZs have been around since the late 1950s in industrialised countries. In 1965, Gandhidham, a city in the Kutch district of Gujarat became India’s first SEZ, although it was then known as an Export Processing Zone (EPZ). After Gandhidham, many EPZs emerged across the country, but they were not very successful because of infrastructure challenges.

In 2005, the Indian Government took another shot at SEZs, by introducing the Special Economic Zones Act, 2005, under which it converted many existing EPZs into SEZs. Companies within an SEZ received many tax concessions, such as a 100% income tax exemption on all revenues earned from exports for the first five years of operation and a 50% exemption for the next five years. There were other sops as well such as SEZ reinvestment reserve for another five years, under which companies could reinvest the reserves and get tax exemption.

The policy worked for a while. According to the Ministry of Commerce and Industry, the number of SEZs has grown from 19 before the SEZ Act to 265 today. Ministry data reveals that exports increased from Rs 22,840 crore in 2005-06 to Rs 7,59,524 crore in 2020-21, while investments increased from Rs 4,035.51 crore in 2005-06 to Rs 6,17,499 crore by 2020-21.

While the numbers are impressive, the SEZ policy failed to serve the original purpose that it was intended for, i.e., promoting manufacturing. The biggest beneficiary of the SEZ policy turned out to be the IT sector. Almost 60% of SEZs in the country are in the IT and ITeS sector. Pharma, textiles, steel and other industries probably missed the opportunity. One of the biggest reasons for this is the fact that large-scale manufacturing requires large spaces with world-class infrastructure. Indian SEZs are relatively small, because of problems in acquiring land. For comparison’s sake, in China the average size of an SEZ is about 300 sq. km, whereas in India it is about 1 sq. km.

Ironically, many SEZs had to be de-notified, because of poor market response, lack of demand for space, and change in the fiscal incentive regime. Of the 378 SEZs that received final approval, only 265 are operational today. And even within the operational SEZs, almost 1 lakh acres of land is unoccupied. SEZ exports now account for less than 20% of the overall exports. As is evident, SEZs did not help in turning India into a manufacturing powerhouse, and once the Government withdrew tax benefits, they lost all their appeal.

A review of the existing SEZ Act and Rules has been on the agenda of the Government of India for the last few years, on account of factors such as the need to boost manufacturing to propel faster growth, generate employment in the Indian economy, large unutilised parcels of land, declining attractiveness of SEZ and ongoing disagreement raised by WTO regarding alleged export linked incentives.

The DESH Bill could be the key to reviving SEZs. The new Bill seeks to overhaul the 16-year-old SEZ legislation, to suit the current economic needs. WTO’s criticism of the incentives given to SEZ companies was also critical in framing a new policy. DESH is more broad-based in nature, with the intent to create developmental hubs, that will cater to both domestic and export markets. The hubs will be categorised as enterprise and services hubs. Enterprise hubs will be allowed for manufacturing and services, whereas services hubs will be limited to service-related activities.

To comply with WTO rules, the Government may do away with evaluation based on net foreign exchange. Supplies to DTA units will be on a duty foregone basis to provide a level playing field with export promotion schemes such as Export Oriented Units (EOU) and Manufacture and Other Operations (MOOWR).

DESH may also allow infrastructure status to the units/developers on the lines of other sectors such as roads and airports, so that companies that operate in these hubs have easier access to capital. The new policy proposes to offer tax benefits such as corporate tax at a concessional rate of 15% for greenfield and brownfield units in the developmental hubs.

The new Bill could be a game changer in reviving SEZs. India’s goal of becoming a USD 5 trillion economy by FY2026-27, would require a contribution of about USD 3 trillion from the services sector and about USD 1 trillion from the manufacturing sector. The country needs large manufacturing hubs and DESH hopes to be a catalyst in transforming India into an attractive global destination for manufacturing and services. Will DESH succeed? We will have to wait and watch.