Revamping SEZ policy will support Aatmanirbhar Bharat
India needs to urgently revamp its SEZ policy, as the mandatory requirement on net foreign exchange earnings makes it a subsidy that’s non-compliant to the WTO. Dr Arpita Mukherjee, Professor at ICRIER and Sunil Rallan, CMD, J Matadee Free Trade Zone Pvt Ltd., discuss the possible policy approaches India can take for the new SEZ policy, on the lines of schemes like Manufacture and Other Operations in Warehouse Regulations (MOOWR”).
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Globally, over 140 countries have some form of the special economic zones (SEZs) policy to support exports. Countries such as China, Republic of Korea and Association of Southeast Asian Nations (ASEAN) member countries have used SEZs to promote exports, especially to develop high-end manufacturing exports. India has been one of the pioneer countries to set up an SEZ in Kandla, Gujarat, in 1965.
To attract private and foreign investment, the SEZ Act was implemented in 2005, supported by the SEZ rules, which came into effect on February 10, 2006. As of January 2021, there are 265 operational SEZs, which include 25 multi-product SEZs and 240 sector-specific SEZs. After implementation of the SEZs Act and Rules, the share of exports from SEZs in total exports of India increased from around 5% in 2005-06 to over 30% in 2018-19.
With the advent of the coronavirus (COVID-19 pandemic), disruption of supply chains and global trade slowdown, Indian exporters are going through one of the most uncertain times in history. Merchandise exports have reduced from US$ 313.36 billion in 2019-20 to US$ 290.18 billion in 2020-21, according to provisional data provided by the Department of Commerce in April 2021. Due to the second and even stronger wave of the pandemic in April 2021, exports in the FY 2021-22 are also likely to be adversely impacted. Reviving exports, therefore, is now a priority of the Government.
In February 2021, the Indian Ministry of Commerce and Industry pointed out that Special Economic Zones (SEZs) continue to take the lead in expanding exports for India. According to data provided by the Department of Commerce, SEZs have shown resilience during global trade volatility and have achieved US$ 100 billion of exports in FY 2019-20. Exports from Indian SEZs are presented in Table 1.
Exports from SEZs
In INR crores
|2018-19||2019-20||2020-21 (as on December 31, 2020)|
|Total Exports from SEZ’s||701,179||796,669||553,396*|
Source: SEZ Factsheet, Ministry of Commerce and Industry. Available at http://sezindia.nic.in/upload/602380372b1efMX-M452N_20210210_153158.pdf (last accessed April 22, 2021)
*This data is available only till December 31, 2020.
Investments in SEZs have also increased (see Table 2), showing a continued interest of domestic and foreign companies in Indian SEZs. The total employment in SEZs increased from 134,704 persons in February 2006 to 2,284,948 persons as on December 31, 2020.
Year-on-year total investments in SEZs
In US$ million
|FY 2017-18||FY 2018-19||FY 2019-20||FY 2020-2021(as on December 31, 2020)|
Source: Compiled from Progress of SEZ’s in India. EPCES. Available at https://www.epces.in/facts-and-figures.php#hpgallery-5 (last accessed April 21, 2021)and SEZ Factsheet, Ministry of Commerce and Industry. Available at http://sezindia.nic.in/upload/602380372b1efMX-M452N_20210210_153158.pdf (last accessed April 22, 2021)
Note*: Investment data for FY 2020-21 is available only till December 31, 2020.
However, there is one major concern. A majority of SEZ exports are in services, unlike China or ASEAN and other South Asian countries. Most of the SEZs in India are in the IT/ITeS sector as shown in Table 3 and India has not been as successful as countries such as China, Republic of Korea or Thailand, in using its SEZs to be a part of global value chains in high-end modern manufacturing. This is because the Indian SEZ policy is not compliant with the World Trade Organization’s (WTO) Agreement on Subsidies & Countervailing Measures, also known as the SCM Agreement.
Table 3: Distribution of approved SEZs in India by top five sectors (as on September 14, 2019)
|Sector||In-principle approval||Formal approval||Notified SEZs||Operational SEZs|
|Pharmaceuticals and chemicals||2||17||17||14|
Source: Compiled from http://sezindia.nic.in/upload/uploadfiles/files/SC%20wise.pdf ; http://sezindia.nic.in/upload/uploadfiles/files/Sectorwi.pdf (last accessed April 4, 2021)
The Issue: Compliance of Indian SEZs with the WTO’s SCM Agreement
As a founding member of the WTO, India has to abide by the WTO agreements to which it is a signatory. While the SCM Agreement does not mention SEZs explicitly, various rules within it apply to the governance and regulatory structure of these zones, more specifically the provision of fiscal incentives in the form of subsidies. Under this agreement, export-linked subsidies are prohibited subsidies and WTO members like India, which have reached a certain per capita income threshold cannot give such subsidies. Through its SEZs policy, India gives a number of fiscal and non-fiscal incentives to SEZ developers and units.
Other countries also offer various incentives, but many of them like China, Taiwan and Vietnam have made their incentives WTO compliant. Contrary to them, in order to avail the fiscal benefits, the units located in Indian SEZs must fulfil the mandatory requirement of being positive net foreign exchange (NFE is calculated on a cumulative basis for the first five years of operation) earners in a block of five years. This condition makes it an export-contingent fiscal incentive. Such incentives have been referred to as a prohibited subsidy under the WTO’s SCM Agreement.
In 2018, the United States of America (USA) took India to the World Trade Organization’s (WTO) Dispute Settlement Body regarding this export linked subsidy given to SEZ units. On October 31, 2019, India lost the case in the WTO and the Board agreed that the subsidies given by India to the SEZs are prohibited subsidies. Subsequent to this, the Department of Commerce has engaged in extensive consultation to redraft India’s SEZs policy. However, the new policy is still not in place, keeping these SEZ units in an uncertain situation and delaying investment in high-end manufacturing SEZs.
As can be seen from Table 3, the number of notified SEZs is far higher than operational SEZs. An SEZ becomes operational when it can attract one unit into the zone. Thus, while developers are setting up state-of-the art infrastructure, they are unable to attract manufacturing units to their zones, despite the fact that with the growing geo-political tensions with China, companies from many countries like the United States of America (USA), European Union member states, Japan and Australia are now exploring India as a base for their manufacturing.
The Solution: Make SEZs WTO compliant by Aligning it to the MOOWR Scheme
Most of the WTO members have made their SEZ incentives WTO compliant. There is an urgent need to make our SEZ policy WTO compliant as has been done by many of our ASEAN and East Asian trading partners. Hence, there are several ways in which WTO compliant incentives can be given and India can learn from these examples. Within India, the Manufacture and Other Operations in Warehouse Regulations (“MOOWR Scheme”), which came into effect in 2019 has addressed majority of the concerns of SEZ developers and units and is also WTO complaint. The MOOWR scheme is designed for Customs-bonded manufacturing cum warehousing of the Central Board of Indirect Taxes and Customs (CBIC), Ministry of Finance. A comparison between the MOOWR scheme and SEZ policy is given in Table 4.
Comparing the MOOWR Scheme with the SEZ Policy
|Terms and Conditions for Units under MOOWR 2019||Terms and Conditions to be met by SEZ Units|
|1||Minimum Area Requirement||No requirement||50 Hectares|
|2||Exemptions -Setting up Unit||No||Yes (including construction costs)|
|3||Exemptions -Plant and Machinery||Yes||Yes|
|4||Exemption- Raw materials||Yes||Yes|
|5||Dutiable Value – Domestic Tariff Area (DTA) Sales||Reversal of duty forgone||Invoice Value into DTA|
|6||Reverse Job Work for DTA Clients||Allowed||Not Permitted|
|7||Net Foreign Exchange (NFE)||No such requirement||Mandatory Requirement for Units to get fiscal Incentives|
|8||License and renewal||No license, only registration certificate is required. Once the registration is completed it does not have to be renewed.||License is required and is valid for 5 years. It has to be renewed after that.|
|9||Adherence to Standard Input Output Norms (SION) Norms||SION norms are decided by the Unit||Not Applicable|
|10||Depreciation on capital goods||Not Applicable||Yes|
Source: Compiled by the authors from MOOWR 2019 and SEZ policy
Recommendations and Way Forward
First, there is an urgent need to take out the export obligation for claiming incentives to make the SEZ policy WTO compliant. In the MOOWR scheme incentives are delinked from an export obligation. Hence, there is no issue of export-linked prohibited subsidies, which has been challenged in the WTO by a number of Indian trading partners like the EU and Canada, apart from the USA. Given that India has already lost the case in the WTO, there is an urgent need to delink SEZs fiscal incentives from export obligations and in this context the MOOWR schemes provides the way forward. Many other countries have made their fiscal incentives conditional upon technology, research and innovation or investment. These may be looked into as well.
Second, goods from the SEZs can be sold to the Domestic Tariff Area (DTA) only after meeting the export obligations. There is no such requirement in the MOOWR scheme. This needs to be looked in the context of the recent coronavirus (COVID-19) related global supply chain disruptions and lockdowns where our exporters could not export and had to depend on domestic market for survival.
Further, the country is dependent on warehousing and logistics cum manufacturing SEZs to get a quicker supply of essential medical equipment. The SEZ policy needs to be adaptive to evolving global realities and trade uncertainties. Further, once the NFE is removed, there will be a need for a policy clarity under what conditions goods and services from the Indian SEZ can be sold to the DTA (for example, what percentage of goods and services can be sold to the DTA) on payment of the duties. This will encourage value addition in the country, rather than importing from SEZs of other countries.
Third, in both the SEZs and the MOOWR scheme, imported goods can be stored in a warehouse without payment of duty and the applicable duty is required to be paid only at the stage of their clearance from the warehouse. If these imported inputs are utilised for exports, the deferred duty is exempted. However, in SEZs when sales are made to the DTA, duty is charged on the entire value, including the local value addition inside the SEZ, while under the MOOWR scheme only the goods and components, which are duty free imports are liable for duty while labour and value addition in India is not subject to Customs duty. The revised SEZ policy needs to look into this issue and encourage value addition in the country for the success of the “Make in India” initiative of the Prime Minister.
Fourth, India has signed Free Trade Agreements with countries like Sri Lanka, Japan, South Korea, and ASEAN (Association of South-East Asian Nations), under which India exempts or allows concessional rate of customs duties on many products which is not applicable to goods from Indian SEZ to the DTA. This needs to be rectified and a level playing field needs to be created. SEZs should have the benefits of the zero or concessional Custom duty rates offered under the trade agreements of India.
Fifth, reverse job work is allowed under the MOOWR scheme, while there is no clarity on this subject under the SEZ policy. To explain reverse job work, let us take the example of a foreign company which wants to relocate its unit to India and an Indian company which is already in an Indian SEZ. A German company has relocated one of its manufacturing units to an SEZ in Tamil Nadu from China and would like to relocate more units from China to India.
This company manufacturers state-of-the art gear boxes for use in windmills. While the company wants to shift the entire production from China to India, the gear boxes, which had been imported into India along with the windmills have to be sent to China for servicing simply because reverse job work is not permitted in Indian SEZ units for their DTA clients. This results in delays and huge costs.
India is now focusing on electronics goods manufacturing and many foreign companies are evaluating the Indian SEZs for such manufacturing and relocating their supply chains from China. However, they are very worried about not being able to do reverse job work and service their DTA clients, which has to be delivered only from their overseas factories.
Servicing is a key value addition in terms of employment generation, and it should be done in India. This would have also motivated the foreign companies to shift their manufacturing cum servicing centres to Indian SEZs, making our SEZs a success story and make India “Atmanirbhar Barat”. Even if we look at traditional Indian companies in SEZs like units in gems and jewellery sector, the need to have reverse job work is equally important as has been the case for high end electronic manufacturing.
Gems and jewellery can be exported both from the special economic zones (SEZs) and domestic tariff area (DTA). Units in both SEZs and DTA can avail certain fiscal benefits. There are around 300 gems and jewellery units in Indian SEZs who account for over 30,000 jobs. These units have invested in state-of-the-art technology and have trained and skilled workforce who are mostly permanent employees on a monthly salary basis.
Since the global demand can be seasonal in nature, during lower demand the workforce and equipment are underutilised leading to under-utlisation of existing capacity. This leads to higher costs for companies, impacting their global competitiveness and pricing. At the same time, in India the demand for western jewellery is growing and is being imported by Indian retailers in DTA. If SEZ units are allowed to supply to the DTA on payment of the required duty, on one hand, their cost will be recovered and they will become more competitive, while on the other hand value addition will be in India. Hence, there is a need to have a clear and transparent policy on reverse job work.
Sixth, India has multiple schemes for enhancing production and exports. Yet our share in global manufacturing is not rising and value addition in the country is low. A number of studies, such as one by the author titled “Special Economic Zones in India”, for the SEZ Division of the Department of Commerce, Ministry of Commerce and Industry, have shown that multiple schemes can be counterproductive, unless they are aligned.
The NITI Aayog has also called for aligning and pruning down the number of schemes. The MOOWR scheme is applicable to a standalone unit as well as for units located in an industrial cluster, including an SEZ. If the benefits given under MOOWR scheme is given to units in SEZs, not only SEZs will be WTO complaint but also there will be more value addition, investment in manufacturing and job creation within India. Further, there is need to align the SEZ policy with the forthcoming Foreign Trade Policy.
Seventh, there is need to collate and present data on exports and imports from SEZs by sectors. The manufacturing sectors should be represented with proper classification so that exports and imports from SEZ and DTA can be calculated and monitored. Since SEZ developers and units submit this data to the Development Commissioners office presenting this data at a sector level is not difficult. Data transparency and clarity is needed to argue and win cases in the WTO, for trade discussions and to showcase Indian SEZs globally.
To conclude, it has now been more than three years since India has been challenged in the WTO on its SEZ policy and after losing the case in the WTO in 2019, the policy needs to be WTO compliant at a fast pace. Given that growth in SEZ exports can help Indian exports to grow and revive the overall growth of the economy, bring in investment and create employment, there is an urgent need to redraft the policy and align it with schemes like the MOOWR scheme. This is a scheme of the Ministry of Finance so it is expected that it will be easier for the Department of Commerce to get an approval and easier buy-in from the Ministry of Finance. Aligning both these schemes will not only remove all uncertainties for SEZ investors but also address their concerns of multiple overlapping schemes and policies. It will significantly improve ease of doing business, and importantly attract investment in manufacturing as is envisaged by the “Make in India” and “Atmanirbhar Bharat” initiatives.
Dr Arpita Mukherjee is a Professor at ICRIER. She has several years of experience in policy-oriented research, working closely with the Government of India and policymakers in the EU, US, ASEAN and in East Asian countries. She has conducted studies for international organizations such as ADB, ADBI, ASEAN Secretariat, FCO (UK), Italian Trade Commission, Konrad-Adenauer Stiftung (KAS), OECD, Taipei Economic and Cultural Centre (TECC), UNCTAD and the WTO and Indian industry associations such as NASSCOM, FICCI, IBA, IDSA and EICI. Her research is a key contributor to India’s negotiating strategies in the WTO and bilateral agreements.
Sunil Rallan is Chairman and Managing Director, Chennai Free Trade Zone. The authors can be contacted at email@example.com and firstname.lastname@example.org. Views expressed are personal.