The EU’s Carbon Border Adjustment Mechanism (CBAM) serves as a means for the EU to establish a justifiable cost for the carbon emissions produced during the manufacturing of carbon-intensive goods imported into the EU. It aims to promote cleaner industrial practices outside the EU while safeguarding the integrity of the EU’s climate objectives.

By ensuring that an appropriate price is paid for the carbon emissions embedded in imported goods, CBAM guarantees that the carbon pricing of imports aligns with that of domestically produced goods. This mechanism operates within the framework of WTO regulations.

CBAM is set to be fully implemented by 2026, following a transitional phase from 2023 to 2026. This phased approach coincides with the gradual cessation of free allowances allocated to industries within the EU under the EU Emissions Trading System (ETS), supporting the EU’s industrial decarbonization efforts.

CBAM transitional phase (2023 – 2026) à CBAM Institutionalization

On October 1, 2023, the CBAM commenced its transitional phase, marking the beginning of the first reporting period for importers, which concluded on January 31, 2024. The gradual introduction of CBAM facilitates a cautious, foreseeable, and equitable transition for both EU and non-EU enterprises, as well as governmental bodies.

Initially, CBAM will be applicable to imports of specific goods and identified precursor materials characterized by carbon-intensive production processes, posing the highest risk of carbon leakage. These include cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen. With this expanded scope, CBAM aims to eventually encompass more than 50% of emissions within ETS-covered sectors once fully implemented. The purpose of the transitional period is to function as a trial and learning phase for all stakeholders—importers, producers, and authorities—to gather valuable insights into embedded emissions and refine methodologies for the definitive period.

During this phase, importers of goods falling under the new regulations will only need to report greenhouse gas emissions (GHG) embedded in their imports (both direct and indirect emissions), without the obligation to purchase and surrender certificates. Indirect emissions will be included in the scope after the transitional period for certain sectors (such as cement and fertilizers), based on a specified methodology outlined in the Implementing Regulation published on August 17, 2023, along with its accompanying guidance.

During the institutionalization phase or the regime period, the following will guide all imports.

1. Importers within the EU dealing with goods falling under CBAM’s purview will enroll with national authorities, where they will have the option to purchase CBAM certificates. The pricing of these certificates will be determined based on the weekly average auction price of EU ETS allowances, denoted in €/tonne of CO2 emissions.
2. EU importers will disclose the emissions inherent in their imports and relinquish the corresponding quantity of certificates annually.
3. In cases where importers can demonstrate that a carbon price has been previously settled during the manufacturing process of the imported goods, a proportional deduction can be applied.

Why India Should Be Concerned?

A crucial factor for India’s aspiration to become a $5 trillion economy lies in expanding its exports, with the EU standing as India’s third-largest trading partner, accounting for €88 billion in goods trade in 2021, or 10.8% of total Indian trade. Therefore, it is imperative to analyze the potential impact of CBAM on India’s export competitiveness and assess whether India, as a developing nation, might bear a disproportionate burden due to the EU’s climate policy, along with exploring countermeasures available to India.

Impact of CBAM on India

Between 2019 and 2021, while the EU represented an average of 14.64% of India’s total exports, India’s share of CBAM sector exports averaged at only 6.51%, considerably lower compared to countries such as China, Turkey, Russia, and Ukraine. Moreover, during the same period, India’s exports of electricity, cement, fertilizers, aluminum, and steel to the EU accounted for merely 1.30% of India’s total exports to the EU. However, if CBAM covers only these five high-carbon products, its impact on India would be relatively limited in terms of total exports. Nevertheless, if we consider India’s exports to the EU, more than 50% of Indian exports would fall under the CBAM proposal, significantly impacting India’s European exports.

Further analysis reveals that the iron and steel sector, followed by aluminum, would be most affected by CBAM, with iron and steel exports to the EU averaging 7.4364% of total exports to the EU from 2019 to 2021, and aluminum exports averaging 1.5844% for the same period. Additionally, India’s products tend to be significantly more carbon-intensive than those of the EU and many other countries due to the dominance of coal in India’s energy consumption, with coal-fired power constituting close to 75%, much higher than the EU’s 15% and the global average of 36%. Consequently, higher emissions from iron, steel, and aluminum production in India could lead to increased carbon tariffs imposed by the EU.

Moreover, CBAM is likely to pose challenges to industries exporting to European markets in terms of increased compliance costs, such as monitoring, calculating, reporting, and verifying emissions. Although the current scope of CBAM may be limited to a few sectors, it is expected to expand to other sectors in the future, potentially impacting Indian exports adversely. Additionally, India lacks a domestic carbon pricing scheme, putting its export competitiveness at risk compared to countries with such systems in place.

Measures India Can Take

Despite India’s criticism of CBAM as “the most regressive proposal,” India cannot afford to overlook this policy, especially considering similar mechanisms being considered by other countries like the United States, the U.K., Canada, and Japan. With the USA constituting a significant portion of India’s total exports, it is crucial for India to develop long-term strategies both domestically and internationally to remain competitive in the global economy.

To ready themselves, Indian producers should undertake a comprehensive analysis to pinpoint areas requiring enhancement to meet CBAM standards. They must also establish robust frameworks for monitoring, measuring, and reporting emissions, bolstering internal capacity for compliance. Moreover, crafting a transparent decarbonization roadmap is vital, with actionable steps and timelines for emission reduction. These proactive measures will equip Indian producers to effectively address CBAM challenges and maintain competitiveness in the global marketplace.

On the domestic front, the Indian government can complement existing schemes like the National Steel Policy and the Production Linked Incentive scheme with a focus on decarbonization. Efforts to reduce emissions, such as the GST compensation cess on coal, should be enhanced. Moreover, on the international front, India should negotiate with the EU to consider India’s energy taxes equivalent to carbon pricing for tax reduction and to facilitate technology transfer and financing mechanisms to improve India’s production sector’s carbon efficiency.

Furthermore, India should establish a carbon trading system or align existing mechanisms with the ETS to mitigate the adverse effects of such protectionist climate policies. Strengthening emission monitoring and measuring capacity, as well as promoting intra-SAARC trade, can provide alternatives for carbon-intensive exports. Ultimately, India’s priority should be to safeguard its national interests amidst evolving global trade dynamics while simultaneously pursuing greener and sustainable production practices to align with global climate goals without compromising on developmental aspirations.