SEZs aren't delivering. Time to scrap them?

India promoted Special Economic Zones (SEZs) to accelerate economic development by creating islands of investments that were provided preferential treatment in terms of facilities and taxes. The initial objective was to promote exports but this has effectively expanded to include growth and employment in general.

While the concept of export promotion through Export Processing Zones (EPZs) and Export Oriented Units (EOUs) has existed for long, this did not attract the scale of investments that has been seen since the SEZ Act was notified in 2006.

Only eight EPZs got established in the four decades between 1965 and 2005. In contrast, 315 SEZs were notified in the first three years of the launch of the SEZs. (The eight EPZs have also been converted into SEZs.)

The growth of the SEZs has been eventful. State governments have been quite active in promoting SEZs in their respective regions. Entrepreneurs have been equally aggressive in proposing large investments in response to the tax incentives, the promise of preferred treatment and most importantly, the lure of acquiring large tracts of land. But, the acquisition of land has literally grounded the SEZ scheme.

Violence in Nandigram and Singur in West Bengal, a less violent but successful opposition to the scheme in Goa and opposition to the Maha Mumbai project in Maharashtra are examples of a policy that has gone astray.

Now, with many entrepreneurs seeking extension of time to procure land or to denotify the SEZs they were supposed to develop, the SEZ initiative seems to be a policy gone wrong. The policy may or may not lead to additional growth and employment in the future, but it is generating a lot of resentment. But that is not the only problem.

This is possibly the right time to re-evaluate the merits and demerits of the initiative. We need to assess the scheme's ability to meet its objectives and to measure the costs involved.

A problem with schemes aggressively trying to promote investments in a particular area is that they skew the behaviour of entrepreneurs to a point that leads to misallocation of scarce resources.

Sovereign guarantees and counter-guarantees for investment in power generation in the second half of the 1990s, and the easy availability of private equity funding to dotcom investments around the turn of the century are the best examples of how resources can get misallocated by investment hype. None of these moves succeeded in generating electricity or employment. But, they did postpone the investment that could have gone into manufacturing industries.

Investment into manufacturing picked up only after the dotcom boom went bust. SEZs are doing similar harm today. Investments into these islands are starving investments into the more worthy projects that are outside these islands -- investment that get no sops.

What is the size of the SEZ investment and how important are these in the overall investment scenario today? We turn to Centre for Monitoring Indian Economy's (CMIE) CapEx database to answer these questions.

SEZs accounted for just a shade over seven per cent of the total investment outstanding as of March 2009. Its share has been falling steadily since its peak of 10 per cent as of December 2006.

SEZs accounted for nearly a third of the new investments proposed during the quarter-ended December 2006. This proportion was high during the June and September 2006 quarters as well since this was the period just after the notification of the SEZ policy in February 2006. After this initial rush, new SEZ investment have dwindled.

This one-time rush followed by very small increments thereafter implies that the scheme has not been very successful in attracting investments on a sustained basis. This is strange: A good scheme need not run out of steam so soon.

Alternately, if the scheme is being rationed out, then possibly, discretion in this rationing can cause huge unfair advantages.

Not all of the Rs 630,000 crore (Rs ,6300 billion) of investments outstanding in the 576 projects as of March 2009 are under implementation. Many are in a limbo. We believe that the investments actually under implementation are close to Rs 200,000 crore (Rs 2,000 billion).

This level of investment is too small to make a significant difference to the country's growth rate, employment or exports.

Some projects have been completed. The biggest among these is the Rs 27,000 crore (Rs 270 billion) Jamnagar refinery of Reliance Industries. But, according to reports, the company is more interested in the domestic market than in the export market which is what its SEZ status requires.

According to the CapEx database, 42 SEZ projects with a total investment of Rs 48,776 crore (Rs 487.76 billion) were commissioned as of June 2009. Thus, the Jamnagar refinery accounts for 55 per cent of the total SEZs commissioned and this project seeks to walk out of its SEZ status.

Reliance's Maha Mumbai SEZ project is in trouble because of its inability to procure land. This project, with an investment of Rs 30,000 crore (Rs 300 billion), is among the top four SEZ projects in India.

Implementation of at least 17 projects is stalled for a variety of reasons. At least 10 projects have been shelved and four have been abandoned. The largest project shelved is the Rs 22,000 crore (Rs 220 billion) Kundli-Sonepat multi-product SEZ being set up by Unitech.

The next largest is Essar's Jamnagar petrochemicals project envisaging an investment of Rs 15,000 crore (Rs 150 billion). The four projects shelved are relatively small.

Given the small size of the overall investment in SEZs, the troubles that these go through while being implemented, the resentment they cause, their non-inclusive nature and the mis-allocation of resources that they potentially cause, it is time to take a re-look at the SEZ scheme.

The author is Managing Director and CEO, Centre for Monitoring Indian Economy.