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SpirE-Journal 2006 Q3

Made in India – the next big thing? The Rise of Export-oriented Manufacturing in India’s Special Economic Zones

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“Made In India” – the next big thing?

While China has been trying to follow India’s success in IT, India now hopes to emulate China’s achievements in export-oriented manufacturing. As China did in the late 1970s, India is now unleashing its special economic zones (SEZs) in the hope of stimulating job-creating manufacturing investment. Can India succeed? This article examines whether the SEZs will transform “Made in India” into a global brand.  
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India’s Economic Potential With a population of 1.1 billion and a GDP per capita of US$3,400, India is a rising power that no international company can afford to ignore. In 2005, the International Monetary Fund (IMF) reported India’s GDP to be US$3.63 trillion in terms of purchasing power parity, ranking fourth in the world. By some definitions, India’s middle class consists of 300 million people and its expansion will raise consumption and make economic growth faster and more sustainable. As is well-known, India has developed a world-class information technology and business process outsourcing (“BPO”) sector that exports its services globally. Yet for all of India’s achievements, the country is still wrestling with high poverty and unemployment rates. India may have excelled in BPO, but when it comes to exportmanufacturing, India is the poorer cousin of China. Hence there is great interest within India to promote the export-oriented manufacturing sector through Special Economic Zones or SEZs. A Tale of Two Asian Giants While SEZs represent an opportunity for India to break new ground, the inevitable comparisons with China underline the distance that India needs to traverse to catch up. Currently, India’s projected real GDP growth of 7.2 percent and industrial growth of 7.9 percent are overshadowed by China’s almost 10 percent GDP growth and over 11 percent industrial growth in 2005. India’s overall economic progress is also lagging behind China according to most macro-economic indicators (see Table 1). However, looking behind current economic indicators, it becomes clear that India has a number of fundamental economic advantages over China which may help attract foreign investors into its SEZs. India’s education system produces quality talent. China may have a higher literacy rate of 90 percent as compared to India’s nearly 60 percent. However, the average Indian tertiary graduate boasts a more recognized qualification. The commanding heights of India’s tertiary education sector, the Indian Institutes of Technology, are comparable to the best universities in the world and are widely seen as academically superior to their counterparts in China. With close to 40 percent of its current population under 15 years of age, India can count on a youthful population to support its continued economic growth. By 2015 the median age in India will be 27, whereas China’s media age will increase from 32 to 37. China is facing an aging population with its “one-child” policy that is flipping the demographic pyramid upside-down, compelling a shrinking workforce to support a continually-aging population. The Manufacturing Magnet Every Asian country that has lifted itself out of poverty has relied on a manufacturing boom to do so and India is no different. There is now a consensus within the India government about the crucial need to build the country’s manufacturing sector, just as China began to do in the late 1970s. Partly as a result of opening up SEZs in five coastal cities in the late 1970s and early 80s, China has since developed into one of the most dynamic and fastest-growing economies in the world. Armed with preferential policies to attract foreign capital, boost export-oriented production and market-driven activity, the first Chinese SEZ set up in Shenzen has achieved a phenomenal 38 percent compounded annual growth in its output from its inception to 2003. Today China has five SEZs, including one spanning the entire province of Hainan. In addition, several free trade zones, technological and economic development zones, and hi-tech industrial zones have sprung up, all with the aim of production for export, import of technology, and further spread of economic development into inland areas. Go WestConceptually, EPZs and SEZs are different – the former is an industrial estate whilst the latter is an industrial township. Despite criticisms that India’s attempt to convert its Export Processing Zones (EPZs) into SEZs is an insurmountable task, India has gone fullsteam ahead. The fact that multinational corporations (MNCs) are increasingly flocking to India augers well for the SEZ movement. While over half of India’s economy is servicebased, India’s manufacturing sector is growing at roughly nine percent and India’s exports have been growing at 26 percent annually, even though the SEZ movement can be said to be in its infancy. Many foreign investors now see India as an attractive destination and have described its newfound project as looking “turbulent on the surface but stable underneath”. India’s “stability beneath the surface” arises from:

Low labour costs;
A well-established legal and dispute resolution system
Fully-functional financial institutions and transaction management systems
A large and young population, in contrast to China’s aging population;
Government de-regulation in certain industries;
An English-speaking workforce.

Using China as a model, India has taken the first crucial step in its campaign to attract export-oriented manufacturing, through enacting SEZ legislation. Taking The First Step On 23 June 2005, India enacted the Special Economic Zones Act. It allows the implementation of numerous incentives in approved designated geographic areas called Special Economic Zones, aimed at stimulating economic activity through manufacturing and services. SEZs are scattered all over India (see Fig 2 on the existing SEZs and those currently under development). Cities with sector-specific SEZs in existence or under development include: Currently, experts are studying the feasibility of setting up export-oriented SEZs in Mysore, Kolar, Hubli-Dharwad, Belgaum, Karwar and on the outskirts of Bangalore. Increasingly, such SEZs will make greater waves in the expansion of India’s economy. Benefits Tagged To SEZsBenefits from the Special Economic Zones Act are designed to encourage companies to “go India”. Setting up a centre of operations in an SEZ allows foreign companies to enjoy various forms of low-risk benefits:

A stable and extensive supply of electrical, water, transportation and IT infrastructure within the areas;
Exemption from Service Tax and Central Sales Tax;
Import and export duty exemptions;
Liberalized labour laws at the discretion of the respective state governments;
100 percent foreign equity ownership in numerous industries;
No licenses required for imports;
Import of capital goods, raw materials, consumables and spares are exempted from customs duty;
Exemption on Central Excise Duty for domestically procured raw materials, working capital and consumable spare parts;
100 percent exemption from income for the first five years, 50 percent tax exemptions for the next two years and up to 50 percent of reinvested profits for subsequent three years;
Reimbursement on Central Sales Tax;
Free repatriation of profits;
No restrictions on sub-contraction;
No routine examination by Customs on cargo to be exported or imported; and
Sector and industry specific incentives and benefits for companies setting up shop within

As of April 2006, more than 160 proposals for new SEZ projects have already been accepted for establishment by the Board of Approvals. Investment in the infrastructure of SEZs is expected to exceed US$2 billion. A selling point for Indian SEZs is the fact that more sectors are being allowed 100 percent foreign-owned equity in Indian-based ventures. A number of sectors are subject to automatic approval and the entry process simply involves notifying the Ministry of Finance. However, there are certain sectors where FDI caps on foreignowned equity persist, and others that require approval from the Ministry of Finance. A Helping Hand Agencies have also been developed to draw investors into India, one of which is the India Investment Centre. The organization has been set up by the government to facilitate investments and the entry of investors into India. It provides information on the SEZs’ incentives and regulations, helps companies obtain the necessary licenses, and assists in networking with the relevant agencies as well as potential business partners. Another government agency is the India Trade Promotion Organisation, which terms itself as the nodal agency for the promotion of external trade with India. The organization supports both local and foreign investors via fairs and exhibitions, networking programs and industry information to develop India’s international trade. Below, we examine four industries that are receiving much attention from these agencies and will be among the most promising drivers of SEZ investment in India – telecommunications, biotechnology, electronics and automotives. Telecommunications With a subscriber base growing at an average rate of 26 percent from 2003 to 2005, the telecommunications industry presents huge opportunities to manufacturing investors. In May 2006, the Minister of Communications and Information Technology announced a plan to target 500 million phones in India by 2010, effectively one phone for every two rural houses (India currently has 150 million telecommunications consumers). The government will facilitate an additional US$10.88 billion for investment in hardware manufacturing. With no restriction on foreign equity holding in the manufacturing of telecommunications equipment, the prospect of 350 million new phones being sold over the coming five years presents an immense opportunity to hardware manufacturers. Furthermore, mobile lines have overtaken land lines. India is currently one of Nokia’s largest markets. In 2005, Nokia India’s revenues were estimated at US$2.02 billion, contributing 6 percent of its global sales. The company’s manufacturing facility in Chennai produces 30 million mobile phones annually, accounting for 10 percent of its global volume. Motorola has also jumped on the bandwagon and recently signed a Memorandum of Understanding with the Tamil Nadu Government to set up a US$100 million manufacturing facility. These examples point towards a bright future for telecommunications in India. A case in point – Telkom Malaysia acquired 49 percent of India’s Spice Telecom and is seeking to expand its India network further. Biotechnology and Pharmaceuticals Revenues in India’s biotechnology industry have crossed the US$1 billion mark and grew by over 35 percent in 2006, which explains why India’s Ministry of External Affairs is prioritizing biotechnology and healthcare to attract FDI. A case in point was the inauguration of a sector-specific SEZ with no FDI restrictions in the drugs and pharmaceuticals industry in Pune early 2006. The 55-acre zone is a US$260 million project located a few hours from Mumbai. The liberalization of the insurance sector and fast growing purchasing power of the Indian consumers have fuelled growth in India’s pharmaceuticals and healthcare industry. Healthcare spending is expected to increase from its current US$17.2 billion to US$40 billion by 2012, with the private sector forming a sizeable portion of this market. Coupled with this is the influx of medical tourism, as costs in India’s medical sector are estimated to be a tenth of those in United States.Demand from medical tourists is expected to attract investment in state-of-the-art healthcare facilities in India going forward. The National Capital Region is becoming a healthcare hub, with various medical centres emerging around the Delhi and Gurgaon area. Artemis Health Institute, for example, is developing a 500-bed multi-specialty hospital in Gurgaon by 2007 and is hoping to further expand its presence in 20 cities. Automotive and Electronics production Two highly technology-intensive sectors of manufacturing – electronics and automotive – are thriving in India. Chennai is home to many international automotive manufacturers, including a factory that produces a new car for Hyundai every minute. BMW is also developing a 22-acre car assembly plant to manufacture its 3 Series and 5 Series, by 2007. It targets to produce 1,000 cars in its first year of operation and 1,700 in the following year. These factories in Chennai contribute to India’s 15 percent annual growth rate in automotive manufacturing – a sector which includes local manufacturer Bajaj Auto, which produced 2.4 million vehicles in 2005. On the electronics front, computer manufacturer, IBM, plans to increase its current level of investment in India threefold to a hefty US$6 billion in the next three years. The booming electronics industry benefits not only multinational white goods manufacturers like LG, Samsung, Sony and National, but also local giants producing consumer durables, such as Videocon, Godrej and Onida. To date, the SEZ project has delivered results, but will this be enough to attract the vast pools of foreign investment that India seeks? Conclusion: Pockets of Potential India has certainly come a long way in attracting foreign investment. Yet even with all the recent advances, India still lags behind China as an export-oriented manufacturing location. However, India’s ambition and growth potential is capturing the imagination of the international manufacturing community – especially because of its booming domestic market. Will the SEZ movement succeed in transforming India into a global manufacturing leader? Unquestionably, India possesses strong fundamentals for becoming a manufacturing hub. These include an abundant supply of well-educated labour, a tradition of domestic manufacturing exemplified by companies like Bajaj and Videocon, a fast-growing market of middle-class consumers and, for the most part, political stability. To this list of advantages, the SEZ movement has added a strong dose of political will to attract FDI – often a decisive factor in winning big FDI projects. However the greatest obstacle to India’s emergence as a manufacturing superpower remains its weak infrastructure. Manufacturing in today’s world is inescapably dependent on a robust electricity grid, good roads as well as efficient ports and airports. Foreign investors and Indian government leaders alike are acutely conscious of India’s deficiencies on these fronts, as reflected in India’s frequent black-outs and brown-outs as well as 32-hour waiting periods for deliveries even between well-connected cities like Kolkata and Mumbai. In response to these problems, the Indian government has begun establishing SEZs near ports and harbours, while welcoming a certain amount of foreign investment in port and airport management. In tackling India’s infrastructure woes, the Indian government will need to overcome the financial constraints posed by its large structural fiscal deficit. This argues for the need to explore innovative financing models for infrastructure development – BuildOperate-Transfer (BOT) projects for example, or the liberalization of FDI into the infrastructure sector. In an undoubted sign of things to come, India was recently ranked in the top five on the list of preferred Asian manufacturing locations in a Spire Research and Consulting survey of MNCs. Provided India’s government can muster the political will to address India’s infrastructure bottlenecks, the future looks bright for India’s SEZs – and the “Made in India” brand.

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