45 Special
Economic Zones Face the WTO Test
Purpose of SEZ:
The Indian SEZ policy was designed with the intention of
promoting exports, bringing in private investment in world-class infrastructure
and global best practices in zone management, and creating employment
opportunities. It is believed that firms operating in SEZs can gain
efficiency and competitiveness through leveraging economies of agglomeration
and scale. To promote these zones and to attract units to operate from them,
the Government of India offered several fiscal incentives both to developers of
SEZs as well as to the units operating from within the SEZs. The incentives
granted by the central government are summarised in Table 1. Apart from these,
SEZs may also be eligible for incentives from the states wherein they are
located.
For the units located in SEZs, to avail these benefits,
there is a mandatory requirement that they must be net foreign exchange (NFE)
earners in a block of five years. The NFE is defined as the value of exports
from a unit of an SEZ minus the value of total imports made by that unit
of the SEZ.
Weaknesses of
Indian SEZ
Despite these facilities and fiscal incentives offered by
the government, the performance of SEZs in India has not been very encouraging.
Exports from SEZs have stagnated since 2012–13 and only in the last two years
has there been some revival. Recent reports indicate that in 2017–18,
total exports from SEZs have grown 15% in rupee terms (Moneycontrol 2018).
However, one may also want to look at the import figures to understand the
trend in net exports from SEZs. The performance of SEZs, in terms of generating
employment and attracting foreign direct investment (FDI), has not been up to
the desired mark. On the other hand, opportunistic use of the SEZ policy has
resulted in controversies and corruption. Many SEZs have been criticised for
their inability to attract global manufacturing units or develop global value
chains, unlike countries such as China for being an instrument of land grab,
being a conduit for huge amounts of revenue foregone, bad zone management, and,
in some cases, smuggling (Reuters 2014). We have discussed these issues in more
detail in Mukherjee et al (2016).
Procedural issues also clog the system. Even though SEZs are
zero rated, the goods and services tax (GST) refund system (for domestic
producers supplying to SEZs) remains a problem area and needs to be simplified.
Fine-tuning GST procedures will help in raising competitiveness of the SEZs.
Also, the general ease of doing business in India is low. As per the World
Bank’s “Ease of Doing Business 2018” index, India was ranked 100, which was an
improvement of 30 places from the previous year, but still lower compared to
competing countries such as the Republic of Korea (4), Malaysia (24), Thailand
(26), Vietnam (68), and China (78), which have successful SEZs.
Finally, things could have been better in Indian SEZs in
terms of input cost. In many cases, power supply is erratic and the cost of
power is much higher than in competing countries such as China. This increases
cost of production. Firms in SEZs have to invest in power back-up systems. If
companies had access to good quality power at cheaper rates, it would have
benefited them more than those subsidies that fall under “actionable” or
“prohibited” categories.
New Challenge from
USA
Special economic zones (SEZs) in India are likely to face a
spate of new challenges from some of India’s major trading partners. Recently,
the United States (US) has submitted a request for consultation to the
Chairperson of the Dispute Settlement Body (DSB) of the World Trade
Organization (WTO).1 In this document, the US has suggested
that India is unfairly subsidising its exporters through various fiscal
incentives and subsidy programmes. According to the United States Trade
Representative (USTR), many of these subsidy programmes are prohibited by the
Subsidies and Countervailing Measures (SCM) Agreement of the WTO. The subsidy
schemes mentioned by the USTR include the fiscal incentives given by India to
its SEZs. If the US manages to prove that these subsidies are indeed
prohibited, as per the WTO definition, then India will have no option but to
remove a large number of incentives given to SEZs. This may have serious
implications for these SEZs.
India’s SEZ policy is facing charges from the US that the
fiscal incentives given to SEZs in India are in fact subsidies and
are non-compliant under the WTO’s SCM Agreement. An accompanying press release
by the USTR (ustr.gov 2018) has alleged that
through
these programmes, India provides exemptions from certain duties, taxes,
and fees; reduces import duty liability; and benefits numerous Indian
exporters, including producers of steel products, pharmaceuticals, chemicals,
information technology products, textiles, and apparel. According to Indian
Government documents, thousands of Indian companies are receiving benefits
totalling over $7 billion annually from these programmes.
The document further says that through these policies, India
is creating an uneven playing field in international trade which is
subsequently harming domestic workers in the US. Therefore, the US would
respond to this threat with all available tools, including petitioning the
WTO.
This is a credible threat by the US. In the last few years,
analysts have also raised questions on WTO compliance of India’s trade
incentive policies.2 If the US can prove in WTO that some
of the export incentives provided by India are “prohibited subsidies,” then
India will be forced to remove these subsidies according to the WTO rules. This
will affect a large amount of merchandise exports from India.
India : No Longer
LDC
Until 2017, India was insulated from these threats from
other WTO members as it gained immunity under “Special and Differential
Treatment” for developing countries and least developed countries (LDCs) under
the SCM Agreement. Article 27.2 of the SCM Agreement exempts LDCs and
developing countries with a per capita income of less than $1,000 from the
prohibition of export subsidies. The list of countries which were eligible for
this exception is given in Annex VII of the SCM Agreement. However, India has
graduated from this list in 2017. Based on the notification issued by the
Committee on Subsidies and Countervailing Measures dated 11 July 2017
(G/SCM/110/Add.14), India can no longer qualify for this exception which it
earlier received as a developing country. Hence, after 2017, export-linked
incentives given to Indian SEZs can now face action under the WTO rules.
Way Ahead
In the WTO SCM Agreement, there is a possible loophole that
India is hoping to exploit. It allows an eight-year graduation period (from the
date of entry into force of the WTO Agreement) for developing countries. During
this period, developing countries are allowed to continue with their
export subsidies without any threat of retaliation. This period has ended in
2003, as WTO was implemented in 1995. However, it is not explicitly mentioned
in the agreement whether the Annex VII countries are eligible for this
eight-year transition period after their graduation. India is arguing that
after its graduation from the Annex VII list, it should get another eight years
to phase out its export subsidies.4 It will not be easy to get
this additional flexibility as it may require a possible amendment and
modification of the original SCM Agreement. It will be difficult to get
countries to agree to such an extension given that India is one of the top
countries against which the maximum CVDs have been imposed. A report published
by the Third World Network mentions that the US has opposed this idea. It
reports that the US’s view is also supported by the European Union and Turkey.5 Moreover,
minutes of an SCM committee meeting of the WTO published in January 2018 show
that the US and Japan have asked India to remove its export subsidies.6 Given
such opposition, it is unlikely that the eight-year extension sought by India
would be allowed.
The second alternative can be to remove the export
contingency clause of the incentives given to SEZs. In that case, these
incentives will no longer be categorised as export subsidies. Instead, India
can link the incentives to other performance indicators such as employment
creation, technological upgradation, high-value manufacturing and services, and
so on. Such benefits can still be “actionable” under the WTO law, but the
importing country has to prove injury. Since Indian SEZs are not major
exporters of manufactured goods, it may be difficult for the importing country
to prove injury.
The third option can be to reorient subsidies exclusively
towards services. Since the WTO is yet to develop a discipline on subsidies in
services, subsidies given to services fall outside any WTO discipline. With
increased “servicification” of manufacturing, services used by SEZ units can be
subsidised. Subsidies can be given to compensate for the logistics services
costs, labour transport costs, labour training costs, advertising and marketing
costs, to name a few.
The fourth option is to focus on non-fiscal benefits and
incentives. However, studies have shown that non-fiscal incentives enjoyed
by Indian SEZ developers and units are far less than those offered by countries
such as the Republic of Korea, China, the Philippines, and Bangladesh. For
example, in the Philippines, economic zone enterprises registered with the
Philippine Economic Zone Authority (PEZA) can employ non-resident foreign
nationals in supervisory, technical, or advisory positions. The PEZA helps in
visa processing, and foreign nationals in a PEZA-registered enterprise are
given special non-immigrant visas with multiple-entry privileges. To encourage
foreign investment and improve living conditions of foreign nationals, the
Republic of Korea allows the establishment of foreign educational institutes
and foreign hospitals in free economic zones (FEZs). Such facilities are not
available in India. Such incentives are difficult to challenge in the WTO and
are known as “smart” subsidies. Moreover, SEZs were proposed to receive
single-window clearance for central and state-level approvals, which has not
happened. Due to their inability to get non-fiscal incentives, companies in
Indian SEZs are more dependent on fiscal incentives than companies located
in SEZs of competing countries.
Summing Up
Exports from SEZs are facing a definite threat. It is
important that for WTO compliance, greater emphasis is laid on the difference
between export promotion practices that are prohibited and those that are
merely actionable. It will be important to design smart policies to minimise “prohibited
subsidies.” To reiterate, it is possible to subsist with measures that are
merely “actionable,” but “prohibited subsidies” should be checked as much as
possible. In this changing global environment, where protectionism is raising
its head, continuing with the existing pattern of export incentive schemes will
no longer be a viable policy option for India. A rethink of strategy is
urgently required.
Xxx
Appendix – Meanings
of ‘Subsidies’, ‘Specific Subsidies’, ‘Actionable Subsidies’, ‘Prohibited Subsidies’
The WTO SCM Agreement recognises that since certain
subsidies are trade distorting, it is important to impose disciplines on these
subsidies. To achieve this goal, the WTO has established a set of rules to
govern subsidies and export incentives in its member countries.
The SCM Agreement defines the term “subsidy” based on three
basic elements. To qualify as a subsidy, a measure must be (i) a financial
contribution (or revenue foregone); (ii) it has to be made by a government or
any public body within the territory of a member; and (iii) it should confer a
benefit to the recipient.
All three criteria must be met for a subsidy to exist.
However, even if a measure is a subsidy as defined in the SCM Agreement, it is
not subject to the disciplines of the SCM Agreement unless the concerned
subsidy is a “specific subsidy.” By “specific subsidy,” the SCM Agreement
implies those subsidies that are specifically provided to an industry, a
region, an enterprise or industry, or a group of enterprises or industries. In
other words, the SCM Agreement will treat a subsidy as a “specific subsidy” if
the granting authority limits access to the subsidy to certain enterprises or
certain regions. Specific subsidies are “actionable” under WTO and
countervailing duties (CVDs) can be imposed against exports that receive
specific subsidies. However, to impose CVDs against “actionable subsidies,” a
country, say, CountryA, must prove that subsidised exports from the concerned
country, say, CountryB, is harming the domestic industries of CountryA. Proving
such injury is complex and may take considerable time and resources.
But, in the WTO SCM Agreement, any subsidy which is export
contingent is a “prohibited subsidy.”3 If a country is
found to be giving “prohibited subsidies,” the concerned WTO member countries
must go through a rapid dispute settlement process and, if found guilty, will
have to remove these subsidies. This is the biggest difference between
“actionable” and “prohibited subsidies.”
In discussing India’s SEZ policy, we mentioned that all the
incentives given to SEZs are conditional on positive net foreign exchange
earnings (NFE>0 for a five-year block). The US argues that this requirement
implies that fiscal incentives given to SEZs are export contingent and, hence,
are “prohibited subsidies.” Therefore, exports from Indian SEZs should face
action from other WTO member countries.
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