While doing some research on the Special Economic Zone (SEZ) policy, I came upon this observation. The basic irritant in the face-off between India and China is the 'subsidy' that the Chinese system gives to its industries…low-cost or free capital, that either come from legacy 'communist' assets, the
State-Owned Enterprises (SOEs). Or the explicit subsidies that China gives to its industry, which are discretionary (ie, by administrative whim) and non-transparent. Take the SEZ policy. China created these 'bubbles', that are a world of their own, with taxpayer funds. The entire environment in these zones is built to please the incoming investor; existing reality can be completely wished away. India finds it difficult to build these 'bubbles', and its SEZs are bogged down by the surroundings they are situated in. SEZs in India have not taken off because politicians find it difficult to pander to the industrial investor, who may have the money, but does not have any votes. In this trade-off, the vote-bankwallah always wins. China has no such problem.
So India handed over the SEZ to private promoters. However, two problems got in the way. One, private investments seek self-sustenance, ie, they must deliver a return on investment. Two, the feeder units to the SEZs (water, power and other services) had no incentive to deliver better quality. The Chinese again have no problem.
Here's my idea. Suppose India's SEZ companies were given a special status, say, as 'infrastructure companies'. These companies would be entitled to issue a special category of long-term (5,10,15, 20-year) bonds, whose coupon would be market-determined. Capital adequacy and repayment risk would be monitored by a market mechanism. The kicker: these bonds would qualify for Section 88-type tax (deduction) benefit. Simultaneously, the PPF rate is dropped to the GOI bonds level. The immediate consequence: PPF money would flow into these companies.
Now, to sweeten this further, the government issues an edict saying no-questions-asked on the source of the subscriptions, a kind of backdoor Voluntary Disclosure Scheme (VDIS). Maybe 20 per cent of the black money in the country would flow into these bonds (provided the government's promise about continuity of such a policy is credible).
Look at what it will achieve. Effectively, it disintermediates the government out of the "administer tax-allocate funds-invest in assets-build infrastructure" loop, which is very inefficient. Less than 10 per cent of the taxes we pay, ends up building any kind of assets, leave alone world-class infrastructure of the kind that will keep international investors happy. All infrastructure funding is coming from the fiscal deficit, which would reduce to the extent that these SEZ cos take the burden (of infrastructure funding) off the government.
These bonds would get traded on the secondary market, and prices would correct to the point where the yield on the bonds would be below market prices of mainstream bonds (the yield curve would get very flat, even inverted, because investors would want to delay receipt of principal). This would encourage issue of more long-term bonds, with commensurate back-to-back investment.
The 'subsidy' provided by long-term investors would be the 'tax rate', which would be market-determined. Since most of this money is anyway outside the tax net, the existing tax base is not cannibalised. Given the lower cost of collection, lesser leakages, this 'tax' system would be much more 'asset-efficient', ie, much more assets would be built per unit of 'tax'.
And if you add the tax collections from the incremental investments into the SEZ, the tax-efficiency of this policy would be even higher. The key assumption here is that under the current tax regime, whoever can evade taxes, is doing so. This market-based structure would harness much of that money.
Sanjeev Pandiya is a private investor. He teaches Corporate Finance & Strategy at Xavier Institute of Management, Bhubaneswar (XIM-B). He also works in the private sector.
This article was originally published on July 12, 2005.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
