August 29, 2007

Special Economics (of) Zamindari

WARNING: Long-ish :)

A lot has been said about the SEZ controversy. Some call it a land grabbing scam while others have been proposing it as the panacea to our structural problems.

Why are SEZs arousing so much interest? Well one, it’s a bonanza for the developer. Business margins in real estate construction are close to 90% in the case of commercial projects like SEZs. (In the residential housing market they are 100-200%. It is lower in SEZs because money is recovered through leases over longer period of time). Running an SEZ involves just the Property Tax and normal Admin expenses.

So what does the developer do? He puts up 20% of the money, borrows 70% and collects 10% in advance bookings. Since land acquisition would be a difficult and costly affair he creates a separate company (also called a special purpose vehicle, SPV) in which he and a Govt. body are partners. The Govt. body’s sole purpose is to acquire contiguous tracts of land; and land is acquired for a song.

It is because of this that the ‘SEZ Policy’ has attracted investors from all walks of business, and primarily from the IT sector. As IT companies expand, they require more and more place to seat their ever increasing workforce (since seats is the primary driver to secure those multi-million/billion dollar outsourcing / software maintenance contracts). Today the IT and BPO industry are accounting for 70% of the real estate demand and more than 60%-70% of the SEZs are meant for the IT / ITeS industry. The rest are distributed among sectors like biotechnology, gems & jewellery, automobiles and the like.

But do we really need SEZs for IT? In reality, the IT chaps derive very little benefit in being part of an SEZ since the tax incentives they already enjoy and those in an SEZ do not vary much. The only industries that will benefit immensely are those that can integrate their process inside an SEZ (i.e. have most of their business partners from raw material to end product). The ease of flow of business and the added incentive of customs waivers and tax benefits will accelerate their growth. China has adopted this model. Shenzen is a massive 50,000 hectares and I don’t think IT companies are housed inside. India’s largest on the other hand, the Reliance promoted Navi Mumbai and Maha Mumbai are collectively 14,000 hectares. Most of our other SEZs are in the sub 500 range catering mainly to the IT sector.

So do we really need so many SEZs? The answer is yes. We require SEZs for small and medium enterprises; lots of them. The software industry is mature enough to fund their own buildings. Which brings us to the next question: Why all this brouhaha in the media? A few points follow.

One, current land owners are not compensated enough: True. Govt. vehicles ensure that the SEZ land is acquired cheap
Two, we are losing agricultural land: False. Land has to be put to its best use. If we (India’s GDP) gain more by setting up an SEZ rather than agriculture, it makes more sense to go for the former. In this age of global linkages we better not be thinking micro.
Three, Farmers lose their livelihood: Partly answered by point one. Farmers should be compensated adequately for their land and for their occupation. Options include training them in a new skill, ensuring a certain percentage employment in the SEZ, or even a share in the SEZ profits.
Also these three points have been magnified by political parties for vested interests.

I am sure that if the powers that be have a more humane look at the issues in an SEZ, all parties can share in the economic boom, farmer and developer alike. Till that happens though we will be transforming IT companies into real estate banks.

(Afterthought: IF the sides of the table were interchanged and farmers were developers and vice versa what would the reaction be? Would capitalism or socialism triumph? Me says capitalism since man is inherently selfish and 100% so in the matters of money. Which of the hardened socialists would not want to get his stuff at a lower price? If so then there is nothing emotional about this issue, it’s just power politics at play!)

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