SEZ's --- quick glance!

They worked in China. But will India's zones boost investment, or just divert it?

IT RESEMBLES the rows that have dogged every step taken by the two-year-old government led by Manmohan Singh, India's prime minister. The government's economic reformists, of whom he himself is the most distinguished, promote a liberalising measure that will help boost investment, fix India's lousy infrastructure and create jobs. They find themselves howled down by a coalition of their Communist allies, leftists in Mr Singh's own Congress party and other activists, who accuse them of being anti-poor. The latest confrontation, however, over the development of Special Economic Zones (SEZs), is different. This time the criticism comes not just from the usual suspects but also from some of the reformists, many economists and even some leading industrialists.

The idea is simple enough: SEZs are enclaves with streamlined procedures, tax breaks and good infrastructure that will lure investors in export-oriented industries. Many developing countries, including China, have used them successfully. They are not even new in India. In 2000 eight existing “export processing zones”, the first of which dated from 1965, were converted into SEZs. But in February India's Parliament finalised a new SEZ law, offering even more enticements. There has since been the bureaucratic equivalent of a gold rush. Companies, including most of India's most famous firms, have filed more than 400 applications to set up SEZs, and 212 have been approved.

Banging the drum for India as an investment destination in London this week, Mr Singh and his commerce minister, Kamal Nath, were able to point to the SEZs as evidence of India's new openness. Mr Nath's ministry hopes they will attract more than $5 billion in foreign direct investment by the end of 2007—a huge amount for India by historic standards (see chart). They are also intended to fix India's “infrastructure deficit” of pot-holed roads, clogged ports and intermittent power. The government hopes that with the incentives available in SEZs, the private sector will make a big contribution towards the $320 billion-worth of investment in infrastructure that India is looking for in the next five years.

That is a laudable enough aim. But the SEZs are under fire on many fronts. Politically, the most sensitive charge, and the one that will probably lead to some change in policy, is that farmers are being forced to sell their land and lose their occupations, and that state governments and developers are profiteering. Sonia Gandhi, Congress's leader, says that agricultural land normally should not be used for SEZs. But under India's constitution land is an issue for state governments, not the centre.

Many of the SEZs mooted may simply be property deals. Developers hope to acquire cheap land, put in a minimum of infrastructure and sell it. Only 35% of the land area of a SEZ must be used for production. Even the central bank, the Reserve Bank, seems to have suspicions, classifying loans to SEZs as “real-estate” lending, which makes them relatively expensive.

Even some investors planning to manufacture in a SEZ think the terms too generous. They include a five-year holiday on profits tax, and exemption from import and excise duties and from some licensing requirements. Rahul Bajaj, chairman of Bajaj Auto, a maker of two- and three-wheeled vehicles, argues that “any rational businessman would conclude he is better off being in a SEZ.” Since, to qualify for the benefits, a manufacturer in a SEZ need only be a net earner of foreign exchange over a five-year period, rather than exclusively an exporter, firms such as his can use a SEZ to supply some of their domestic market.

The fear of many economists—including some in the Ministry of Finance—is that rather than promoting new business, the SEZs will merely attract investment that would have been made anyway. Instead of finding fresh sources of money for its infrastructure, India would thereby have made things worse by depriving itself of tax revenue. Raghuram Rajan, chief economist at the IMF, expresses concern that India, with its big fiscal deficit, can ill afford this loss. Earlier this year the finance ministry put it at 1,750 billion rupees ($38.3 billion) by 2011. The commerce ministry counters with its own forecast that the SEZs will generate additional revenues of 440 billion rupees.

One of the big differences between India's SEZs and China's is in size. Although Reliance Industries, India's biggest private-sector company, is planning enormous, town-sized, SEZs near Mumbai and in Haryana, near Delhi, most of the others are tiny. The minimum area for a “multi-product” SEZ is 1,000 hectares (3.9 square miles), for a “product-specific” zone, it is 100 hectares, and for information technology, biotechnology and jewellery, just ten hectares. By comparison, Shenzhen, biggest and most famous of China's original SEZs, covers 126 square miles. That scale was a huge factor in its initial success— along with the presence, just over the border in Hong Kong, of labour-intensive manufacturers wanting to lower their costs. Enjoying neither of these advantages, India's smaller SEZs may do more for their promoters than for India.