China’s success in attracting export related FDI and its success in labour intensive exports contrasts sharply with that of India. Many of the policy reforms that are politically difficult in India were equally difficult in China. China however was able to introduce these reforms on an experimental basis in their Special Export Zones and then use the demonstrated success of these reforms to make them deeper and wider. This is an example worth emulating.
A number of surveys have shown that the key problems with respect to FDI are Bureaucratic red tape, Labour laws, rules & procedures and Private infrastructure policy and regulatory systems (“Foreign Direct Investment Reform,” Arvind Virmani, Occasional Policy Paper, ICRIER, April 2004; http://www.icrier.org/FDIsgpc03.pdf). Though the first best solution would be to improve these across the country, this could take decades. The Central and State SEZ laws should cover industrial, labour, environmental, infrastructure and administrative issues, with a view to simplifying and promoting investment and production in the SEZs. Though tax neutrality is an objective, the purpose is not to give sops and incentives that distort the system and are not sustainable .
Though it will take a decade or more to improve infrastructure services across the country, infrastructure availability and quality can be brought to global standards in the Special Economic Zones (SEZs) within a couple of years. The effect of a weak highway and railway system can be minimised by locating SEZs in the coastal regions as was done by China and many other countries in S. E. Asia. Among the measures needed for accelerated development of Infrastructure in and exports from SEZs are;
a. Power generation and distribution for the SEZ needs to be isolated from the crumbling SEBs to the extent possible. As size limitations make electricity generation for the SEZ (alone) non-optimal, the private electricity generator for the SEZ should be allowed to sell excess power to parties outside the SEZ subject to transparent wheeling charges and cross tax-subsidy arrangement.
b. There should be free entry and exit of Telecom service providers into the SEZ without any service or USO charges, subject only to the condition that the spectrum would be auctioned if and only if it ceases to be a “free good” within the SEZ. Inter-connectivity with other countries (ILD) should be free and unrestricted (subject only to the condition that this cannot be used as a conduit for provision of unregulated telecom services into the DTA). Automatic 100 per cent FDI should be allowed.
c. Private parties would also be free to set up a private airport or port to service the SEZs with automatic 100% FDI. If an unused harbour is not available nearby, the requisite number of berths in the closest port should be made available to private parties for the purpose of servicing the SEZ. These parties (or another developer) should be given the authority to set up toll highway connecting the port to the SEZ.
d. A law should be passed by the State governments under which 100% privately owned townships can be set and run by private developers as private municipalities. Private SEZs should be designated as private municipalities under this law and road, electricity transmission & other linkages provided by State/Central govt.
A number of other legal and bureaucratic changes can also be introduced much more quickly in the SEZs than is possible in the country in general. The applicable laws, rules, regulations and procedures in the SEZs should be made as attractive as in China’s coastal regions & other competing destinations. This requires,
a. Elimination of all price controls & distribution controls (e.g. on Power, Rents),
b. Removal of all investment restrictions (e.g. SSI reservation, foreign equity limits & bans, public sector reservation) for production and supply within the zone or for export. This would include removal of State & local restrictions (eg. Urban land ceiling, retail trade, real estate).
c. Removal of all capital account restrictions/controls/prior permissions for businesses operating within the SEZ (reporting requirements and regulations relating to inflow of Foreign exchange debt etc. into DTZ would remain).
d. International standard financial regulations for financial institutions operating within the zone with our unique Indian “controls” eliminated. Thus the FDI limits on Banking, Insurance, NBFCs would not apply, directed credit & SLR would be eliminated and CRR brought down to internationally comparable levels.
e. Customs, Excise & Service tax laws to be modified so that all transactions within the SEZ are exempt and transaction of DTA with the SEZ can be treated as if with a foreign country. Normal excise (& customs) rules would no longer apply for transactions within the SEZs. Customs and Additional duty (equal to CENVAT/Excise) would apply to all sales to DTA. SAD should not apply as state sales and other taxes would apply on DTA sale. State sales tax law should also be modified, so that within the SEZ only sales to resident consumers (not producers/traders) are taxed. No excise/CST/ST/Octroi would be charged for sales from DTA to SEZs.
f. Normal personal and corporate income taxes would apply, but not the surcharges, cesses, MAT or any other temporary/special imposts. The depreciation rate should be globally competitive.
g. A new labour law incorporating a work ethic. Abolition of Contract Labour restrictions. Freedom for multiple and night shift for workers of both sexes. Designation of Development Commissioner as Labour Commissioner.
h. An integrated unified industrial regulator (i.e. only one inspector for all continuing industrial regulations including pollution, labour safety).
i. Designation of the Development Commissioner as the Commissioner under all the relevant laws (industrial, environmental etc.) within the SEZ.
j. A modernised judicial sub-structure for SEZs that deals with cases in a time bound manner.
In fact we should experiment with an even bolder model of a market economy with no controls and restrictions complemented by a modern regulatory system based on trust that punishes violators quickly and effectively like the traffic light approach. For some regulations, self-certification may be adequate while for others outside (private) certification eg. by an accredited professional or certification agency) may be required.
A special marketing effort is needed for export oriented FDI. For instance, Taiwanese and other exporters in East and S.E. Asia can be targeted for this purpose. Our missions in OECD and other FDI source countries should be fully briefed on the comparative advantages of SEZs in India and distribute the required literature.