SEZ Review

SEZ Update – Positives outweigh the negatives
➤ Special Economic Zone (SEZ) Policy Overhauled: Late last week, the government lifted the ban on SEZ’s that was imposed in Jan07 following protests seen in W Bengal by families displaced by land acquisition1 for SEZs.
The amendments relate to size, processing area, forex earnings and the role of state – most of which we believe are positive. We thus maintain our view that benefits in terms of infrastructure, trade, employment and investment could offset the negatives, with SEZs serving as catalysts to growth rather than fostering unbalanced development.
➤ Key parameters that have been amended include:
1. Land ceiling: The upper limit of the area for multi-product SEZs has now been capped at 5000 hectares. However, state governments can prescribe a ceiling lower than 5000 hectares. In addition, there is also a cap of 12,500 hectares for a single applicant. While this could impact the mega SEZ plans of Reliance, DLF, Omaxe, Unitech etc, it is reported that companies are looking at options such as splitting the SEZs to comply with the new rules3 2. Processing Area: The minimum processing area has been uniformly raised to 50% for all SEZs. Earlier, the minimum processing area was 35% for multiproduct SEZs and 50% for sector-specific SEZs. This could adversely impact developers who initially intended to use 65% of the SEZ land to build hotels, malls, schools and entertainment centres.
3. Land acquisition and rehabilitation: The onus of land acquisition will now fall on the private sector as compared to the earlier rules where states could acquire land. This is positive as in some cases, state governments powers were being mis-used. More-over the new rules will shield the land-owners from the states who had the power to forcibly acquire land for public use under the land acquisition Act.

Current Status on SEZs
Since the SEZ Rules came into effect in Feb 06, the Board has granted formal approval to 234 SEZ proposals, and in-principle approval to 162 proposals. 63 SEZs have been notified. However, with the Nandigram protests, the fate of several SEZs – including projects by Infosys Technology in Pune, Wockhardt at Aurangabad, and Mahindra World City in Jaipur – hung in the balance. This backlog will now be cleared, with the BoA resuming processing approvals. We think the move is an overall positive since it resolves several long-standing issues, and lends much needed clarity to development of these zones.

Are SEZs beneficial?
The concept of SEZs in India has been subject to much controversy and debate over the past year. Although Indian SEZs are much smaller in scale than their Chinese counterparts, we think they are a step in the right direction. While norms may have to be further tightened to prevent leakages, the government's thrust on SEZs coupled with private sector participation is likely to promote industrial activity. Further, estimates by the Ministry suggest that SEZs will bring in investments to the tune of Rs1000bn by the end of Dec07, creating 500,000 direct jobs. Net-net, we believe the benefits that will accrue in terms of infrastructure, trade, employment, and investment will offset the teething problems that SEZs have encountered so far.


Amendments to SEZ Policy over the past year
Over the past year, we have seen a number of amendments to the SEZ Policy. Key amendments during the last year include
1 Companies operating in SEZs would have to make fresh investments in plant and machinery;
2 Companies that import for the purpose of re-export would get tax breaks while those sourcing from domestic tariff areas would not.
3 Earlier the SEZ developer was permitted to allot land to anyone in the onprocessing
area for business and social purposes. These rules were changed so that vacant land can be leased only to a co-developer approved by the authorities.
4 The RBI issued a directive that said all loans given towards setting up SEZs will be treated in the same manner as exposure to commercial real estate, the stock market, and venture capital. This implies higher provisioning norms (100bps as against 40bps for standard loans) as well as higher risk weights (150% instead of 100% for standard loans). Higher capital requirements are yet another way of curtailing fly-by-night SEZs mushrooming over the country, and help retain only the more serious players.
5 Rules regarding minimum investment and net worth have also been amended, with promoters in multi-product SEZ's required to have a net worth of Rs2.5bn and a minimum investment of Rs10bn. (Sector specific Net Worth=Rs0.5bn and minimum investment =Rs2.5bn).
6 In contrast to the earlier rules where units had to be net forex earners over the first five years to get SEZ benefits, under the new rules export earnings from SEZs
will now have to be equivalent to their purchases from domestic areas.