With the 25,000-acre SEZ in Haryana taking shape, and with Maharashtra setting the pace with reforms to labour law in SEZs, India seems to be effectively moving forward on the agenda of creating Special Economic Zones. On one hand, an effective SEZ policy could bolster India’s growth, by making a dent on urban infrastructure and labour reforms. It could as a consequence have big payoffs in terms of employment and GDP growth. But unfortunately, at the same time, SEZs add to a sombre picture of a second phase of a fiscal crisis. With great difficulty, India has clawed back from a fiscal disaster over the last six years. But early signs suggest that we could slip back to a fiscal disaster by 2010. Proposed expenditures are large while revenue collections could shrink. In the first few months of forming the government, the UPA gave out a very strong message that it believed in fiscal consolidation. Finance Minister P. Chidambaram went ahead and implemented the Fiscal Responsibility and Budgetary Management (FRBM) Act that had been begun by the previous government. A signal was given to the world that despite the support of the Left, the government was not going to run large deficits and fiscal reform will be on track. It was feared that the support of the Left would make the government take up socialist welfare measures. But reality has turned out to be quite different. It is not the Left, it is the Congress Party that has turned out to be the biggest enemy of the fiscal responsibility act. Indeed, the Left’s contribution is, if anything, positive. West Bengal’s finance minister has pushed the state VAT forward, paving the way towards a national level GST. Despite all the talk of Left intellectuals about financing deficits by printing money, at the end of the day, they merely supported continuing old programmes like the PDS and subsidies for LPG, not pushing big new ones. The Congress, on the other hand, with complete disregard of the promises it has made on fiscal responsibility, has initiated large-scale spending programmes such as the National Rural Employment Guarantee Act (NREGA), pumped up the money going into Sarva Shiksha Abhiyan (SSA), initiated the sixth pay commission and a raft of welfare provisions including defined benefit pension for the 400 million unorganised sector workers. When implemented, these programmes could in a few years lead up to additional spending of well over Rs 1 lakh crore. In addition to these spending programmes, there is the populist oil price policy which could ultimately hit the budget when oil PSUs cannot go on making losses any more. And, if that were not enough, the UPA has initiated hundreds of SEZs all over the country, with the most generous tax concessions imaginable. The SEZs could cost the exchequer about Rs 95,000 crore over the next few years. This year the budgeted fiscal deficit has been brought down to 3.7 per cent of GDP. Despite the finance commission adding to the Centre’s deficit by raising the share of revenues going to the states, the FRBM was not thrown completely off-track. The expansion of the service tax net and increase in rates, improvement in tax administration through TIN, and direct tax reform had a positive impact. The UPA has been lucky on GDP growth in the past two years. High GDP and manufacturing growth have resulted in buoyant tax collections. But all this is before really big spending has started. Under the FRBM the government has promised a fiscal deficit of no worse than 3 per cent by 2008-09, and that too only for the purpose of capital expenditure. It, unfortunately, looks increasingly infeasible for the UPA to achieve these goals. A scheme like the NREGA is completely open-ended. The government cannot say that it will only spend Rs 14,000 crore because it has promised to spend as much as there is demand for employment. Moreover, when state governments are allowed to determine the minimum wage that the Centre must pay, the run on expenditure can be without limit when states compete with each other to pay more than one another. The most serious threat to the FRBM will come from the SEZs. Tax exemptions are being given not only to exporters but to real estate developers who are getting a fiscal gift from the government when, after the government acquires land cheap for them, it gives them a tax break when they sell commercial plots and residences (not necessarily to exporters) for a profit. Further, FRBM projections were made on the assumption of a high tax buoyancy. An increase in GDP would lead to a greater increase in tax collections. But now companies have incentives to locate new establishments only in SEZs. Not only is the infrastructure going to be better, they are going to get tax exemptions for profits from exports. It will not be long before companies devise ways to show more and more income as income from SEZ activities. With tax havens inside the country, hundreds of ways will be found to route income so that as little as possible tax is paid. More than a hundred SEZs all over the country are a finance minister’s worst nightmare. Advocates of SEZs look forward to SEZs featuring an immunity from the labour law, poor tax policies and tax administration of the Indian state. The idea is that a SEZ is a place where it becomes possible to hire globally competitive Indian labour without all the terrible impediments thrown up by the socialist state. However, it will be impossible for the SEZs to function without a giant new bureaucracy springing up to plug these leakages of tax. We will have created a new problem for the next generation of reformers to attack. The FRBM was an act of Parliament, but when Parliament itself is merrily passing other acts which show little concerns for the promises it made, who will play watchdog?
