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State Of The Economy 2014

Errorgenous zones
Ernst & Young partner Abhaya Agarwal believes existing clusters need to be bolstered instead of setting up new ones

Abhaya Agarwal

The national investment and manufacturing zone (NIMZ) is a new concept envisioned to revitalise manufacturing growth in the country. The concept of NIMZ was intended to capture the benefits arising out of clustering of manufacturing activities in integrated industrial townships with modern infrastructure, besides improving the competitiveness of industries.

Essentially, NIMZs will have multiple industries located closely so that they can benefit from co-location, further aided by infrastructure and friendly business regulations to lower the cost of production. Clustering has always been advocated in economic theory as a means to reduce the cost of production. Clusters are expected to bring in economies of scale and most developed nations have adopted this approach for industrial development at some point in their economic history. Of late, it has emerged as a major focus of economic policy dialogue given the focus on urbanisation. The development of “industrial corridors” is an extension of the cluster theory and India, in particular, is banking on a cluster-driven approach to industrial development. A closer look at the new manufacturing policy makes you realise that the government is banking heavily on NIMZ as a tool to put its policies into action. The key question is, can it work?

We can seek the answer from our own past experience. India has introduced many schemes and policies to develop clusters across industries. The schemes have been launched for promotion of both greenfield and existing clusters. However, the focus of the government has always been on new greenfield clusters. Governments, both at the Centre and states, have promoted SEZs, mega food parks, IT investment regions, mega leather clusters and the like. However, most of these clusters have fizzled out after the initial euphoria. For example, the government has thus far approved 30 mega food park projects, of which two projects, in Andhra Pradesh and Uttarakhand, are partially operational. Similarly, SEZs, which were lapped up eagerly by both the government and the private sector, have now lost their favour with developers and industries alike. Of the 588 SEZs approved since 2005, only 79 are operational (19 were already functional prior to the SEZ Act!). In fact, many developers are surrendering their approvals. The board of approval on SEZs has denotified 58 zones as of July 2013 and many more are in the offing.

While developers have quoted several reasons for pulling out, ranging from economic meltdown, poor market response, non-availability of skilled labour, and imposition of MAT and DDT on SEZs, all these point at a basic problem — investors continue to face ground-level infrastructure and regulatory issues. The cost of power remains high for industries located in these new clusters. Taxation and associated administrative hassles have only reduced marginally. Single-window mechanism is not effective owing to poor coordination between departments of central and state governments. Thus, industries have little incentive to shift their production to new clusters, while for developers land acquisition issues and lack of trunk infrastructure do not justify the return. 

Designed to fail

We have opted to take only easy steps rather than introducing difficult reforms and actions. Large numbers of SEZs were given approval without resolving the land acquisition part and providing proper infrastructure outside the zones. Cenvat was not implemented fully and comprehensive computerisation and simplification of the excise or Modvat system continues to be slow. Some of the cluster initiative seems to have been launched without a roadmap. For example, the imposition of MAT and DDT on SEZ entities defeated the entire purpose of SEZs. Providing cheap and reliable power to these clusters was never part of the intrinsic agenda of a development plan. Land acquisition continues to be a major roadblock and government authorities are reluctant to acquire land in the current environment. Industrial corridors and NIMZ, touted as the harbinger of industrial development in the country, are unlikely to make any significant impact on economic growth, given the experience of SEZs. Above all, with rapid strides being made in technology with things like 3D printers that are likely to result in structural changes in manufacturing, can we afford to experiment with another ‘zone’ and squander a few more years? 

A Bird in hand...

The efforts should shift towards improving existing clusters rather than creating new ones. Existing clusters — an outcome of market forces despite policy and regulatory constraints — will be in a better position to exploit the advantages of better infrastructure, ease of labour, tech upgradation, skill availability, and administrative and tax simplifications. The government already has several schemes to strengthen existing clusters. The focus now should be on removing complex infra bottlenecks and implementing challenging reforms. The benefits proposed to be made available for NIMZ, such as job loss policy, expeditious approvals and clearances, ‘green’ incentives, etc., should be extended to brownfield clusters.

Projects such as dedicated freight corridors should connect existing clusters through a dedicated rail line rather than utilising the existing railway network, which is choked with passenger traffic. Investments should go towards exclusive power plants and common effluent treatment plants, rather than developing so many new cities. The financial costs of implementing these projects will be much lower than those for developing numerous new cities. Additional economic and social benefits will also accrue from strengthening of existing clusters instead of thinking of building new ones. Most of the clusters have already emerged as major towns and are facing congestion and high levels of pollution. In the long run, gains from strengthening the existing clusters may far outweigh the gains expected from new ones.

Our past experience shows that developing new clusters with different nomenclatures cannot work without undertaking basic infrastructure, policy and administrative reforms. The time has come to ditch the easy, old-wine-in-new-bottle approach and adopt elementary but thorny measures.

Co-authored by Ankur Goel, senior associate, E&Y

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