An SEZ bubble?

The Reserve Bank of India is worried about a bubble in real estate that may burst. Property prices have doubled or tripled in the last two years, although rents have risen only slowly. The slow rise of rents suggests that the demand of actual users is being met. In which case the frenzy in the market looks a speculative bubble.

One of the aims of the RBI in raising interest rates twice recently is to cool the overheated property market. The RBI has also raised the risk-weighting of housing loans to 150 % to discourage bank lending, and has sought to keep out foreign venture capital funds wanting to get into Indian real estate.

However, it seems to me that the biggest real estate bubble of all may arise somewhere else—in the Special Economic Zones (SEZs) coming up all over the country after the big tax breaks announced for both developers and export units in such zones. A mad rush to set up SEZs has begun, and this looks more a real estate rush than an export rush. The government has allowed up to 75% of the area of SEZs to be used for non-export purposes such as housing, schools, entertainment and banks. Cynics say that exports are merely an afterthought.

The new policy came into force in February 2006. But already 388 applications have been made, of which 105 have received clearance. Maharashtra leads with 63 applications. Remarkably, Haryana, which is a long way from the sea, comes second with 53 applications: and this includes applications from real estate companies like DLF and Unitech. This is probably driven by proximity to Delhi.

Haryana is followed by Andhra Pradesh (51), Karnatak (51) and Tamil Nadu (42).

Gujarat comes way down the list, yet Chief Minister Narendra Modi believes his state will become SEZ capital of India because of the state’s 41 ports, which may be critical for serious export-oriented units.

How much will it cost to develop these SEZs? The sums mentioned can make your head dizzy.

Reliance Industries, for instance, is the main partner in twin SEZs coming up at Navi Mumbai and Maha Mumbai, with a combined size of 35,000 acres. The phase I investment alone is reckoned at Rs 5,000 crore, and the ultimate investment has been estimated at Rs 50,000 crore in seven years or so.

The Adani group is also setting up an SEZ at Mundra, covering 30,000-35,000 acres, and it proposes to invest Rs 7,300 crore on infrastructure. The SEZ aims at a total investment of Rs 70,000 crore (including that by export units) over ten years.

Many of the approved SEZs may be might be small IT parks, and those will almost certainly be viable—the industry is expanding fast and will probably fill up the space. But the same cannot be said of large real estate developments. For instance, DLF plans SEZs at Ambala (2,500 acres) and Gurgaon (19,880 acres) while Unitech plans one at Sonepat (10,000 acres).

Real estate developers are happy to get their hands on large parcels acquired at low prices by state governments. Development by itself greatly increases land value. But the aim here is supposedly to promote exports, not real estate.

What is the guarantee that enough export units will flock to these new SEZs, especially to those in states far away from good ports? Just the infrastructure cost of developing 388 SEZs could exceed Rs 100,000 crore. I have seen nothing to justify the pious hope that exporters will quickly fill hundreds of SEZs, some of which are massive.

What is the advantage that inland locations like Haryana will bestow on export-oriented units? Some products can be exported by air, and in such cases proximity to a cargo airport might suffice. Yet the bulk of exports go by sea, not air.

If SEZ developers spend huge sums on infrastructure and are unable to attract enough export units, they will quickly run into a financial crisis arising from over-building. The SEZ bubble will burst, and it will be a large explosion.

SEZ developers say they cannot give guarantees of entry from export units at the very outset: they hope these units will come up over 7-10 years. But what if they don’t?

There is a danger here for small shareholders, bondholders and banks. Small shareholders are currently excited by real estate prospects, and will probably rush to buy shares in SEZ companies. They need to be warned that the risks are significant, especially for inland locations and non-proven promoters.

SEZ promoters will seek to raise bonds and bank loans that are several times as large as their equity. Banks need to be cautious about lending, and the RBI needs to watch carefully. Better be safe than sorry.

One thought on “An SEZ bubble?

  • 2013.Mar.19 at 14:49
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