The international evidence on successful special economic zones underlines the significance of strategic location, geographical size, functional autonomy, efficient administrative frameworks and leading role played by private developers as the key drivers of success. However, a critical factor in determining the success of private zones is availability of finance for developers. This is probably one of the main reasons behind the presence of large real estate firms in India?s SEZs

The intensity of the debate on pros and cons of land acquisition in India has diverted attention from the financial feasibility of India?s privately developed zones.The fixed costs of SEZs include those for acquisition of land and development of internal infrastructure. Developers with bigger land banks are certainly in more advantageous positions for managing land costs. But even then they have to bear substantive costs of developing zone infrastructure, particularly in the bigger multi-product zones of more than 1,000 hectare. This is where the Indian SEZ policy is different from that in China, where considerable start-up infrastructure was state-developed. This is also where the pitch has become queer for most developers with serious implications for financial stability of zones.

Projecting infrastructure development costs are always difficult in an economy such as India that is prone to cost-push price pressures arising from supply-demand mismatches. Unanticipated cost escalations are major problems in this respect. Such escalations become more difficult to manage at times when revenue flows are moderating due to poor business prospects.

A bigger problem for many SEZs, however, is accessing finance at reasonable costs. India?s SEZs have been unfortunate victims of extreme perceptions between government agencies. While the Ministry of Commerce has pushed their growth aggressively, RBI treated them on par with commercial real estate. As a result, loans for SEZ developers are treated as those with higher risk weights and come with higher price tags. High domestic interest rates have been one of the major reasons behind Indian corporate accessing overseas capital markets. The interest arbitrage opportunity created by large spreads between domestic and overseas lending rates encouraged Indian firms to raise extensive resources from overseas markets. But in this respect as well, SEZ developers have not had things going their way. The SEZ policy discriminates between zone developers and units in SEZs in mobilising resources through external commercial borrowings (ECBs). While SEZ units are allowed to raise ECBs up to $500 million per year without any maturity restrictions, developers cannot do so, since such borrowings have end-use restrictions for commercial real estate development.

Restrictions on accessing finance left several developers with little options other than exploring collaborations with foreign partners. However, the global downturn has created problems in this respect as well. Collaborative ventures can no longer rely on their foreign parents as lenders of last resort. Problems have been further compounded by sub-rule (9) of Rule 11 of SEZ Rules of 2006 that prohibits selling of SEZ land. Many developers are now stuck with land without enough resources for developing facilities.

Certain activities in SEZs, are likely to get infrastructure status. These are primarily of a developmental nature. If developers avail bank loans for building zones and repay the same through revenues generated by use of facilities by internal units, or through its own cash flows, then developing zone will be tantamount to creating infrastructure. However, if the repayments are made on the basis of sale proceeds or rental earnings then the same will be treated as commercial real estate exposure.

It is difficult to understand why developers will be treated unfavourably if they lease out the developed facilities. If creating durable infrastructure assets through private initiative is one of the objectives of the SEZ policy, then why should trading in these assets be viewed adversely? This is counterproductive to the logic of involving private initiative in the SEZ process. Why penalise the developer for earning good returns on a well-developed asset?

Many will argue that matters might still improve partly if some of the activities get infrastructure status while most don?t. Principles of elementary welfare economics will justify situations where welfare of some increase while that of others remains same. The eventual outcome is an improvement in collective welfare.

But will ?infrastructure? status really turn things around? It will make bank loans available at 2 % lower rates. But given the sensitiveness of Indian banks to non-performing assets (NPAs), funds are unlikely to flow to SEZs till banks are satisfied about their financial viability. The latter depends on business prospects.

The author is a visiting research fellow at the Institute of South Asian Studies at the National University of Singapore. These are his personal views