The Hindu Business Line : OECD raps India's SEZ policy

Following the criticism of India's special economic zones (SEZ) by the IMF and the World Bank, the Organisation for Economic Cooperation and Development (OECD), an inter-governmental think tank of 30 rich industrial countries, too has cast doubts about the viability of SEZs in delivering results without widening the existing divide and entrenching distortions in the economy.

In a forthcoming study by the Paris-based OECD on "Realising the Potential of India's Trade Integration" to be discussed in a workshop by CUTS International, a non-Governmental organisation, on September 21 here, the OECD economists, Mr Premyslaw Kowalski, and Ms Nora Dihel contend that "it is doubtful whether export-related duty exemptions and preferential treatment of economic agents operating in the SEZs are the best way to promote economic efficiency and growth".

Negative incentives

The study said that the 2005 trade-weighted average tariffs of close to 52 per cent in agriculture and 12 per cent in manufacturing still imply a significant wedge between domestic and world prices and act as an indirect tax on export through imports. This puts many domestic producers that rely on imported inputs at a competitive disadvantage while shielding uncompetitive domestic producers from competition.

"Maintaining moderately high import tariffs along with a system of export-oriented duty exemptions can be characterised as a system of `negative incentives' where a common denominator means costs of production that are higher than in other less protected emerging markets with the exception of those that are currently competitive. This is bound to have a negative impact on the Indian economy in general and perhaps even on exports since this activity is also carried out within an inefficient national economy, they said adding that as much as 75 per cent of capital formation in the SEZs emanates from domestic sources.

The authors ask whether it is wise to promote exports through a dual system of taxing the national economy with inefficiencies and simultaneously promoting selective investments in exporting activities within the SEZs.

On duty cuts

The study said that an across-the-board import duty cuts could have more beneficial economy-wide and export effects than selective duty exemptions in export sectors. A brief assessment of Indian operations and fiscal implications of Indian SEZs to date, the OECD study said, suggest that the value added generated annually by the SEZs might be rather close, if not lower, than the amount of tax revenue foregone, given that the share of costs of intermediate inputs in the final value of Indian products often substantially exceeds 50 per cent. It is precisely on this proposition that the Ministry of Finance has been attacking the sops provided to SEZs rather in a veiled way and also got the revenue foregone by such sops included in the expenditure budget document in recent years.

The RBI has also voiced reservations in lending to SEZs stating that they should be treated as real estate business, even as the Commerce Ministry wants the SEZs to be treated as infrastructure project for investment purposes by the commercial banks.

More suggestions

The OECD report argues that this and other elements in its analysis suggest that the economic benefits of the SEZs in India are open to question, despite the private sector support and the government's gusto. As a recent OECD study underscored, SEZs are always a "suboptimal policy from an economic point of view" as they could merely provide a palliative to "countries with poor business milieu where bridging deficiencies at a national level is temporarily impossible."

While this may appear to be the case in India - a large, low income country with enormous population, poor infrastructure and fiscal problems - it would not be rational to treat this as "a sustainable, long-term solution that can substitute for reforms aimed at making business easier for everyone", the economists argue.

They said India's dynamic, sustained and balanced economic growth could continue only if it manages to harness the growth of its human capital by sustaining improvements in investment and productivity.

"It is doubtful whether export-related duty exemptions and preferential treatment of economic agents operating in the SEZs are the best way to promote economic efficiency and growth".

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