Special Economic Zones

• D.Madhu Babu,

Vice President,

IL&FS Clusters

• Structure of Presentation

– General Economic Change

– Concept

– Procedure

– Services by Professional Managers

Even though the world hasjust discovered it, the India

growth story is not new

It has been going on for 25 years

28 years of high growth

1.0

3.5

6.0

8.9

Average annual GDP growth

0

2

4

6

8

10

1900-1950 1950-1980 1980-2002 2002-2007

(%)

Population growth is slowing

Sources: 1900-1990: Angus Maddison (1995), Monitoring the World Economy, 1990-2000:Census of India (2001)

1.0

2.22.1

1.8

1.5

0

0.5

1.0

1.5

2.0

2.5

1901-1950 1951-1980 1981-1990 1991-2000 2001-2010

(%)

Literacy is rising

Source: Census of India (2001)

17

52

65

80

0

20

40

60

80

100

1950 1990 2000 2010 (proj)

(%)

When middle class is 50% then the politics will also change

Source: The Consuming Class, National Council of Applied Economic Research, 2002

65

220

368

8%

22% 32%

0

100

200

300

400

1980 2000 2010

(m)

Poverty is declining

46

26

16

1% of the people have been crossing poverty line each year for 25

years

Equals ~ 200m

0

10

20

30

40

50

1980 2000 2010

(%)

Per capita income gains

Source: World Bank

US$ ppp

200520053,0513,051

19801980

1,1781,178

Drivers of growth

India– Domestic– Services– Consumption– High tech, capital

intensive industry

East and S.E. Asia – Exports – Manufacturing – Investment – Low tech, labour

intensive industry

Implications of India model

‘Domestically led’ means:– Insulation from global downturns– Less volatility– We will come out of the global crisis

faster

Implication of India model

‘Services led’ raises uncomfortable questions:

■ Have we skipped the industrial revolution?

■ How do we take people from farms to cities?

■ Will SEZ’s be our tipping point?

Implication of India model – Consumption led

41%

45%45%

59%

U.S.

China

Brazil

India

33%

People Friendly:Consumption as % of GDP

People Friendly, Less inequality: Gini Index

58%

42%64%

Europe

China

India

Will India become the next big consuming economy after the U.S.?

Reasons for success

India’s success is market-led whereas China’s is state induced

The entrepreneur is at thecentre of the Indian model

India has a vibrant private space

– 100 Indian Companies have market cap of US$ 1bn – 1,000 Indian Companies have received foreign

institutional investment– 125 Fortune 500 companies have R&D bases in India– 390 Fortune 500 companies have outsourced software

development to India– 2% bad loans in Indian banks (v~20% in China)– 80% credit goes to private sector (v~10% in China)

Key reforms

– Opened economy to trade and investment– Dismantled controls – Lowered tariffs– Dropped tax rates– Broke public sector monopolies

Understanding India’s economic success

Remarkable --every government has reformed (slowly)

since 1991 Even slow reforms add up 65 countries have done the same reforms – why did India

become the second fastest in the world? Unappreciated fact – rule of law

Where are we today?

Growth fell to 6.7% in 08-09; 7% in 09-10 Pain has been less than in China Competitive companies have recovered faster. Risk of protectionism has receded Recovery has been ahead of the world

Where are we going?

– Base case post recovery is 7.5 % – 8.5 % GDP growth – Democracy will not permit more than 8% unless you have a

Thatcher– 1.5% population growth – Demographic dividend – growth will continue beyond China’s

Per capita income

2,1003,050

5,800

16,800

37,000

On a ppp basis

2000 2005 2020 2040 2066

0

10

20

30

40

($000)

What could stop the show?

- Infrastructure

- Improving via public-private parterships - Fiscal Deficit - Governance

None of these stopped the show in the past 25 years

Changing Role of Government

• ‘Facilitator’ of private investment by creating an enabling environment

• ‘Provider’ of gaps in critical infrastructure to encourage investment

• ‘Partner’ of the private sector in ‘public-private’ partnerships

• ‘Investor’ in social sectors such as health, education, etc., to serve the needs of society

Private Investment play a Bigger Role

• Public investment will always be majority

- but private investment around 20% of total infrastructure investment in developing countries

• In India private investment in infrastructure around 1% GDP, half what was hoped for

• Comparisons

- Chile : 3-4% GDP since 1996, Brazil c.1.5% 1997-2001. Colombia 2-3% since 1996

- China : private investment 10% of road program,

- .4% in India

Current Scenario of Special Economic Zones (SEZ)

• SEZs are defined as “delineated duty free enclaves and are deemed foreign territories for purpose of trade operations, duties and tariffs”

• Goods going into the SEZ area from Domestic Tariff Area (DTA) shall be treated as deemed exports and goods coming from the SEZ area into DTA shall be treated as if the goods are imported

8 Functional SEZs

Santa Cruz/Mumbai

Noida

Kandla

Cochin

Kolkata

Surat

Vizag/ Kakinada

Chennai

Special Economic Zones (SEZ) - As on Oct ’10

• Formal approval has been given for setting up of SEZs in various parts of the country by the private sector/ State Government (After SEZ act/ Rules notified)

• In principal approval has been given for SEZs

• Most approved SEZs are in IT and ITES

• Textile SEZs – Formal approval – • Sector specific) in principal approval –

Expanding exports and increasing forex

earnings

Transfer of technology and

modern management skills

Government’s Objectives for setting up SEZs

Creating multiplier effect on the overall

economy

Generating employment opportunities

Stimulating efficient use of domestic

resources

SEZ’s are given advantageous environment to attract

investments and achieve high growth with positive spillover

effects on overall economy

Envisaged “Pillars” of the SEZ concept”:

• A Bundle of fiscal incentives to zone investors, zone occupants and zone suppliers

• An overall Zone governance that provides for efficient unhindered business activities particularly for export oriented enterprises

• Superior infrastructure of global standards

Envisaged “Pillars” of the SEZ concept”:

• A Bundle of fiscal incentives to zone investors, zone occupants and zone suppliers

• An overall Zone governance that provides for efficient unhindered business activities particularly for export oriented enterprises

• Superior infrastructure of global standards

Overview of SEZ Concept

• SEZ Policy announced in April 2000, to provide internationally competitive and hassle free environment for exports.

• SEZ Policy– Central SEZ Act, 2005– Central SEZ rules, 2006– State SEZ Acts - Gujarat, Uttar

Pradesh, Madhya Pradesh

• Indian SEZ policy based on the extremely successful Chinese format to promote exports, attract FDI and foster overall economic growth

– Shenzhen SEZ, started in 1981, has achieved CAGR of 38% mainly owing to:

• Liberal economic framework• Integrated infrastructure at very

competitive prices

Special Economic Zones

Fiscal Incentives

Fiscal Incentives

Regulatory Freedom and Hassle-free Business

Environment

Regulatory Freedom and Hassle-free Business

Environment

World Class Integrated

Infrastructure

World Class Integrated

Infrastructure

1 2 3

SEZ Policy

• The Special Economic Zone scheme in India was launched in April 2000.

• SEZ units can be set up for – manufacture of goods, rendering of services, production,

processing, assembling, trading, repair, remaking, reconditioning, re-engineering including making of gold/ silver/platinum jewelry and articles thereof or in connection therewith.

• SEZs may be set up in the public, private or joint sector or by state governments

• SEZ should have a minimum area of 1000 hectares

Unique aspects of Indian SEZ Model

• Indian model also envisages private financing of SEZs – Internationally, free zones have been “publicly” funded– In India, fiscal constraints place limitations on public funding of SEZs.

• Financial viability is a key consideration in the Indian context since much of the funding for SEZs is envisaged through private sector/ banks

– Economic and indirect benefits have been the main motivators– Viability of the business model and competitive differentiation would be the key

determinants of bankability of SEZ projects.

• Indian model also envisages private sector carrying out zone marketing.– Internationally, zone marketing has been carried out mainly by governments

• Domestic Investment may play an equally prominent role in Indian context.– Internationally, FDI has been the main driver of zone investments

• In the Indian SEZ model, states are being encouraged to take decisions (location selection, number of SEZs to be promoted and the focus for investment attraction) while the central government is largely focusing on policy-making and facilitation

– Experience of other countries shows that these decisions have largely been influenced by federal governments.

Cheap labour, large market and availability of raw materials has enabled Shenzen to emerge as large manufacturing base

International Experience: Shenzen

• Shenzen – Key Drivers– Strategic location– Large domestic market– Abundant low cost work force– Availability of raw materials– Proximity to Hong Kong– Fiscal incentives– Liberal regulatory framework– Excellent infrastructure,

transport and connectivity– Social infrastructure – Linkages with domestic

industry– Excellent administrative

capability– Delegation of powers to local

authorities – hassle free operations

• Key Industries– Electronic & telecom equipment– Instruments, meters and office

supply machinery– Electric equipment and

machinery– Metal products– Medical and pharmaceutical

products– Food Processing– Garments and other fiber

products– Chemical products– Plastic products– Transportation equipment

International Experience: Jebel Ali

• Jebel Ali – Key Drivers– Strategic location

– Proximity to large consumer markets

– Liberal regulatory framework

– Excellent infrastructure and transportation

– Social infrastructure

– Excellent administrative capability

– Delegation of powers to local authorities - hassle free operations

• Key Industries– Over 2,000 companies from

97 countries have established their business base

– While their businesses span a whole range of activities

• About 74% of the companies hold trading licenses

• 22% hold industrial license• Balance hold service

licenses

Development Components

Off-site Infrastructure

• Transportation linkages (port, airport, roads, etc.)

• Power generation• Power transmission network• Water supply source• Road connectivity to the zone

from port, airport and other parts of the country

On-site Infrastructure

• Land development • Facilities• Internal roads• Electricity distribution system• Telecom system• Sewage and waste water

treatment• Landscaping, street lighting

Social Infrastructure

• Residential accommodation• Commercial development• Schools• Hospitals• Hotels• Leisure, recreation and

entertainment facilities

Key Development Components of SEZ

Cost cannot be recovered from tenants in short to medium term

Cost may be recovered from tenants, if critical mass is achieved

Certain facilities may be developed on commercial basis, if critical mass is achieved

SEZ – Physical Concept

The DC of the SEZ is responsible for demarcating the processing/ non-processing areas

Land/ Built-up space in the processing area to be leased

– To Entrepreneurs holding valid letters of approval, with lease period co-terminus with LOA

– For facilities for exclusive use of the units such as canteens, public telephones, first-aid centres, creches etc

– To a person desiring to create infrastructure facilities for use by prospective units

Developer may allot the land in the non-processing area for business and social purposes as:

– Educational Institutions– Hospitals– Hotels– Recreation & Entertainment

facilities– Residential & Business complexes

DTA units not allowed to set up

Facilities such as Free Trade & Warehousing Zones, International Financial Services Centre may be approved or establishment within the Processing Area

Incentives to Developers, Co-developers & Investors

• Developer of SEZ may import / procure goods without payment of duty for the development, operation and maintenance of SEZ.

• Income tax exemption for a block of any 10 years in 15 years at the option of developer.

• Income Tax exemption also extended to investors in SEZs u/s 10 (23) G of IT Act

• Exemption from Service Tax• 100% FDI permitted to develop township within the SEZ with

residential areas, markets, play grounds, clubs, recreation centers etc

• Full freedom in allocation of developed plots to approved SEZ units on purely commercial basis and complete authority to provide services like water, electricity, security, restaurants, recreation centers etc. on commercial lines

Critical Success Factors for a SEZ

• Location of the SEZ • Offsite infrastructure such as transportation corridor

comprising port and airport connectivity, road & rail access.• Onsite world-class infrastructure such as power, water supply,

sanitation, sewerage and telecom with global benchmarks• Financial creditworthiness of the promoter group and their

ability to finance and develop the SEZ• Efficient and world class zone administration • Zone Marketing to prospective zone (domestic and

international) tenants• Flexible labor laws• Contiguous custom notified area (there should be no area

which is encroached)

Critical Success Factors for a SEZ

• Proximity to large urban agglomerations. Large parts of the SEZ can be utilized for real estate/townships and in SEZs like NOIDA, Navi Mumbai and Vizag, these can be very remunerative for the developer.

• Clear title to land

Common Factors

Key Differentiator

Long Term Success

• Almost all free zones offer similar incentives package

• Most free zones are located close to ports and provide excellent transportation linkages and infrastructure facilities

• Infrastructure facilities and state policies do not provide enduring competitive advantage as these can be easily replicated

• Most successful free zones (such as China and Jebel Ali) have displayed strong administrative capabilities, and actually delivered on their promises

• Administrative capability and the ability to provide facilities and deliver services as promised, has emerged as the key differentiator among free zones

• Proposed SEZ would need to match the infrastructural facilities and policy level incentives

• Planned infrastructure should be established

• Set-up a strong administrative backbone for effective provision of services to ensure long term success

Analysis Summary

Future Investments in SEZ and Typical Funding Pattern

• Expectation of 100-150 major SEZs and 800 minor SEZs to come up in the next 15 years

• Rs. 2,00,000 Cr expected to be invested in this sector

• Typical Funding Pattern– Estimate - 1000 Ha multi-product SEZ would cost about Rs

2000 crores.– Debt-equity is in the ratio of about 70:30– Debt funding is provided by a consortium with IDBI,HUDCO,

IDFC and IL&FS typically in the lead– Commercial banks also participate as consortium members– Loan for a period of 12-15 years with a 3-4 year moratorium

period

Formats for SEZs in India

Special Economic Zone for Multi-Product

• Minimum size – 1000 Ha• Contiguous area required; fulfillment of this to be determined

case to case by the Board of Approval on merit• Minimum size of Processing Area – 25%

Special Economic Zone for Multi-Product, in Special States

• Minimum size – 200 Ha (Contiguous area required)• Minimum size of Processing Area – 25%

Special Economic Zone for Multi-Services • Minimum size – 100 Ha (Contiguous area required)

• Minimum size of Processing Area – 25%

Special Economic Zone for Specific Sector • Minimum size – 100 Ha (Contiguous area required)

• Minimum size of Processing Area – 50%

Special Economic Zone for Port/ Airport • Minimum size – 100 Ha (Contiguous area required)

• Minimum size of Processing Area – 50%

Formats for SEZs in India

Special Economic Zone for Specific Sector in Special States

• Minimum size – 50 Ha (Contiguous area required)• Minimum size of Processing Area – 50%

Special Economic Zone for IT, Biotech, Non-conventional energy or Gems & Jewellery

• Minimum size – 10 Ha (Contiguous area required)• Minimum size of Processing Area –50%• Minimum Built-up space for IT SEZ – 100,000 sq.m

Special Economic Zone for Free Trade & Warehousing

• Minimum size – 40 Ha (Contiguous area required)• Minimum Built-up space for IT SEZ – 100,000 sq.m• May be set up as part of an SEZ for Multi-products• May be set up as part of an SEZ for specific sector, with area not

exceeding 20% of the zone area

International Financial Services Centre

• GoI may approve the setting up of upto 1 IFSC in each SEZ• Regulations to be framed by the RBI, SEBI, IRDA and other

relevant agencies

SEZ Institutional Framework - Overview

Major Authorities

Developer Operations in SEZ - Introduction

SEZ Approval – Procedure

SEZ Notification – Procedure

Grant of Approval for Authorised Operations

Fiscal Provisions relating to SEZ Units