Divisions over a central plank of India's strategy to attract investment deepened over the weekend when Sonia Gandhi, president of the Congress party, added her powerful voice to those urging curbs on new tax-advantaged special economic zones.
Since the passing of the special economic zones (SEZ) Act in February, hundreds of businesses have rushed to take advantage of generous tax breaks, causing consternation in the finance ministry, the central bank and even the International Monetary Fund.
Special economic zones have been established in several countries, most notably in China, where they attracted the foreign investment and know-how that were central to the modernisation programme launched in 1978. However, critics claim SEZs attract investment only by offering distortionary incentives rather than by building underlying competitiveness and can delay real economy-wide reforms.
In a speech on Saturday, Mrs Gandhi, a key influence on the government, said farmers were being unnecessarily displaced by SEZs. So far, 150 SEZ projects have received formal approval and 117 "approval in principle".
"Prime agricultural land should not normally be diverted to non-agricultural uses and, even if this was resorted to for unavoidable reasons, this should not jeopardise agricultural prospects," she told chief ministers of Congress party-ruled states.
But economists believe the proposed SEZs are unlikely to help Indian manufacturers achieve scale efficiencies, since 133 of the 267 are less than 1sq km in area. The average size is just 4.2sq km.
"Mega-sized SEZs are the ideal solution," said Chetan Ahya of Morgan Stanley. "We believe that in today's highly competitive globalised world, the concept of small-sized SEZs is completely outdated."
Kamal Nath, commerce minister and champion of the SEZ scheme, said the combination of high population density and democracy made it impossible for India to follow the Chinese model of giant export-oriented manufacturing zones.
"In a country with our land density, you can't just create 150sq km SEZs like in China," he said. "Every country has its own specific model of SEZ and we see them as a major engine of growth and job generation."
In an attempt to raise the average size, the commerce ministry is in the process of specifying minimum investment levels of $55 million (€43 million) for single-product SEZs and $220 million for multi-product SEZs.
With a further 200 applications in the pipeline, the finance ministry has mounted a rearguard campaign against SEZs, claiming they will cause an unaffordable revenue loss to the government of 900 billion rupees (€15.3 billion) by 2009-10.
Finance ministry officials said the scheme was providing unnecessary tax breaks to real estate development that would have taken place regardless of whether or not there was an SEZ scheme in place.
