Bad Economic Zones

Indian Express, June 24, 2006

With the 25,000 acre SEZ in Haryana taking shape, and with Maharashtra

setting the pace with reforms to labour law in SEZs, India seems to be

effectively moving forward on the agenda of creating Special Economic

Zones. On one hand, an effective SEZ policy could bolster India's

growth, by making a dent on urban infrastructure and labour

reforms. It could, as a consequence, have big payoffs in terms of

employment and GDP growth. But unfortunately, at the same time, SEZs

add to a sombre picture of a second phase of a fiscal crisis. With

great difficulty, India has clawed back from a fiscal disaster over

the last six years. But early signs suggest that we could slip back to

a fiscal disaster by 2010. Proposed expenditures are large while

revenue collections could shrink.

In the first few months of forming the government, the UPA gave out a

very strong message that it believed in fiscal consolidation. Finance

Minister P. Chidambaram went ahead and implemented the Fiscal

Responsibility and Budgetary Management (FRBM) Act that had been begun

by the previous government. A signal was given to the world that

despite the support of the Left, the government was not going to run

large deficits and fiscal reform will be on track.

It had been feared that the support of the Left would make the

government take up socialist welfare measures. But reality has turned

out to be quite different. The Congress Party, and not the left, has

turned out to be the biggest enemy of the fiscal responsibility

act. Indeed, the Left's contribution is, if anything, positive. The

West Bengal Finance Minister has pushed the state VAT forward, paving

the way towards a national level GST. Despite all the talk by Left

intellectuals about financing deficits by printing money, at the end

of the day, they hvae merely supported continuing old programmes like

the PDS and subsidies for LPG, not pushing big new ones.

The Congress, on the other hand, with complete disregard to the

promises it has made on fiscal responsibility, has moved towards large

scale spending programmes such as the National Rural Employment

Guarantee Act (NREGA), pumped up the money going into Sarva Shiksha

Ahiyan (SSA), initiated the sixth pay commission, and possibly a raft

of welfare provisions including defined benefit pension for the 400

million unorganised sector workers. When implemented, these programmes

in a few years, could lead up to additional spending of well over Rs 1

lakh crore. In addition to these spending programmes, there is the

populist oil price policy which could ultimately hit the budget when

oil PSU's cannot run losses any more.

And, if that was not enough, the UPA has initiated hundreds of SEZs

all over the country, with the most generous tax concessions

imaginable. The SEZs could cost the exchequer about Rs 95,000 crore

over the next few years. This year the budgeted fiscal deficit has

been brought down to 3.7 percent of GDP. Despite the finance

commission adding to the centre's deficit by raising the share of

revenues going to the states, the FRBM was not thrown completely

off-track. The expansion of the service tax net and increase in rates,

improvement in tax administration through TIN, and direct tax reform

had a positive impact. The UPA has been lucky on GDP growth in the

past two years. High GDP and manufacturing growth has given buoyant

tax collections.

But all this is before the really big spending has started. Under the

FRBM the government has promised a fiscal deficit of no worse than 3%

by 2008-09, and that too only for the purpose of capital

expenditure. It, unfortunately, looks increasingly infeasible for the

UPA to achieve these goals. A scheme like the NREGA is completely open

ended. The government cannot say that it will only spend Rs 14,000

crore, because by the very definition of the scheme, it has promised

to spend as much as there is demand for employment. Morevoer, when

state governments are allowed to determine the minimum wage that the

centre must pay, the run on expenditure can be without limits when

states compete with each other to pay more than one another.

The most serious threat to the FRBM will come from the SEZs. Tax

exemptions are being given not only to exporters but to real estate

developers who are getting a fiscal gift from the government when

after the government acquires land cheap for them, it gives them a tax

break when they sell commercial plots and residences (not necessarily

to exporters) for a profit. Further, FRBM projections were made on the

assumption of a high tax buoyancy: An increase in GDP would lead to a

greater increase in tax collections. But now companies have incentives

to locate up new establishments only in SEZs. Not only is the

infrastructure going to be better, they are going to get tax

exemptions for profits from exports. It will not be long before

companies devise ways to show more and more income as income from SEZ

activities. With tax havens inside the country, hundreds of ways will

be found to route income such that as little as possible tax is

paid. If incremental GDP is booked in SEZs, then the basic tax

buoyancy assumptions that underlie the FRBM Task Force report will

break down. More than a hundred SEZs all over the country are a

finance minister's worse nightmare.

Advocates of SEZs look forward to SEZs featuring an immunity from the

labour law, poor tax policies and tax administration of the Indian

State. The idea is that an SEZ is a place where it becomes possible to

merely hire globally competitive Indian labour, without all the

terrible impediments thrown up by the socialist State. However, it

will be impossible for the SEZs to function without a giant new

bureaucracy springing up to plug these leakages of tax. We will have

created a new problem for the next generation of reformers to attack.

The FRBM was an act of parliament, but when the parliament itself is

merrily passing other acts which care little for the promises it made,

who will play the watchdog?


Back up to Ila Patnaik's media page