A review of much touted Special Economic Zone policy in a recent Comptroller and Auditor General audit report confirms doubts expressed by economists that it will lead to undue favours to corporates at the cost of substantial erosion in revenue earning for State.

In its performance audit-report on indirect taxes for Union Government tabled in parliament on 11 March 2008, the CAG brought 370 SEZ units under scanner with a limited objective to verify if they had complied with existing Customs Act, Rules, notifications etc. The review brought out systemic as well as compliance weaknesses that caused lost revenues to the tune of Rs.246.72 crores. Furthermore, the CAG threw light on the absence of enabling provisions which resulted in Rs.1724.67 crores of revenues forgone, or irrecoverable.

The Special Economic Zones policy was announced in April 2000 by BJP-led NDA government. The SEZ Act 2005, supported by rules came into effect from 10 February 2006, during the tenure of the UPA government.

There were 154 SEZs in private and joint sectors which had been notified after the SEZ Act came into force, in addition to the 19 SEZs that had existed prior to the enactment of the Act, which functioned from 1 November 2000 to 9 February 2006 under the provisions of Foreign Trade Policy.

Duty foregone by the Government on the SEZ scheme during the period 2000-01 to 2005-06 was Rs. 8,842 crores. The budget estimates of the duty foregone for the year 2006-07 was Rs.2,146 crores.

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One of the main objectives of setting up SEZ was fast-track augmentation of exports. SEZs are a specifically delineated duty free enclave and are deemed foreign territory for the purpose of trade operations, duties and tariffs. Accordingly, goods and services from domestic tariff area (DTA) to SEZ are to be treated as exports and goods coming from SEZ into DTA are to be treated as imports.

The incentives and facilities offered to the SEZs include duty free import/domestic procurement of goods for development, operation and maintenance. At the same time, the SEZ law allows import/export operations on self-certification basis. The units in the zones are required to be a Net Foreign Exchange (NFE) earner, calculated cumulatively for a period of five years from commencement of production.

Additionally, as per the EXIM Policy (2002-'07) and the Foreign Trade Policy (2004-'09) an SEZ unit was required to achieve a positive NFE. For determining the same, Domestic Tariff Area (DTA) sales/supplies effected to other SEZ units, 100 percent Export Oriented Units etc. – deemed export - were also to be reckoned.

The expose

The CAG revealed in audit scrutiny that the policy had not prescribed the extent of foreign exchange that should be earned by an SEZ unit through actual physical export and that which could be earned through deemed export in DTA, to comply with positive NFE provision. Deemed exports in the DTA do not earn any foreign exchange.

It was observed during the audit, that 22 SEZ units had been achieving the prescribed "positive" NFE mainly though domestic sales and this defeats one of the sub-objectives of the scheme, which was to augment real exports. While an overall export of Rs.7,149.23 crores was made by these 22 units, the actual export content was only Rs.1,999.27 crores (28 per cent) and the remaining Rs.5,149.96 crores (72 per cent) related to DTA earnings. The range of the domestic earnings as a percentage of total export earning in these units was 59 to 100. Customs duty of Rs. 1,043.29 crores was foregone on import of goods by these units.

The CAG found that duty was waived twice - first on the inputs used in manufacturing products in the SEZs, and again when the finished products from the SEZs were allowed into DTA at nil rate of duty. The duty foregone on the inputs utilized for manufacture of the finished products could not be recovered, in the absence of the provisions of paying back.

CAG's audit scrutiny explains how this system turned out to be a huge favour for Nokia the well known mobile manufacturer, while putting similar units in the DTA or even in other EOUs at distinctly disadvantageous position. The audit report states without mincing words, "Audit scrutiny of records of Nokia India Pvt. Ltd., a unit in Madras SEZ, revealed that the unit cleared mobile phones with a value of Rs.4,855.69 crores in 2005-06 and 2006-07 in DTA at 'nil' rate of duty. Duty of Rs.681.38 crores (Rs.86.76 crores in 2005-06 and Rs.594.62 crores in 2006-07) foregone on the inputs used in the manufacture of these mobile phones could not be recovered in the absence of enabling provisions."

SEZ units with negative foreign exchange earning

CAG's scrutiny also revealed a failure in recovering duty foregone from units who had not achieved "positive" NFE. The CAG report states, "Scrutiny of records of 24 units of Falta, Cochin, Madras, Kandla and Vishakhapatnam SEZs revealed that these units failed to achieve the required positive NFE. Accordingly, a duty of Rs.106.71 crores (determined in proportion of the shortfall in achieving positive NFE) with interest of Rs.46.17 crores was recoverable from these units."

Instances of sizeable losses to public exchequer don't merely end there. Audit scrutiny also revealed that violations and non-compliances abound in SEZ units even after so many of waivers and exemptions.

Forty one units in Falta, Chennai, Vishakhapattnam, SEEPZ, Kandla and Surat SEZs had violated conditions of their Letters of Permission (LoP). The violations included (i) carrying out trading activity though the LOP was for manufacture, (ii) manufacturing in a premises not mentioned in the LOP, (iii) excess trading than what was permitted in the LOP, (iv) operating without a valid LOP, (v) clearing all goods in DTA despite the facts that these were required to be exported to the general currency area (GCA) countries, and more. They attracted penal action as per provisions in Foreign Trade (Duties and Regulations) Act 1992 and to pay duty totaling Rs.74.90 crores.

The criticism of systemic and compliance weaknesses of India's SEZ policy in the latest CAG audit report and the impact in revenue losses needs to enter the SEZ debate. Much of the current criticism leveled against SEZs has focused on its impact on agricultural lands in the hands of farming communities. The CAG's report has shown that SEZs are not poor public policy just socially, but economically as well.