Carbon Border Adjustment Mechanism (CBAM) 2023

Policy Update
Anusuya Choudhary

The Carbon Border Adjustment Mechanism (CBAM), addresses the carbon costs paid by EU that adhere to the EU Emissions Trading System (ETS). This experiment is a step towards climate change regulation to tackle carbon leakage. There is a chance of so-called “carbon leakage” as the EU increases its own climate ambition and as long as many non- EU nations continue to have less restrictive climate policies.

Carbon leakage happens when EU- based businesses relocate their carbon-intensive production to nations with laxer climate regulations than the EU, or when EU products are replaced by more carbon-intensive imports. It operates by levying a tax on the carbon emissions in a subset of imports that is equal to the tax levied under the ETS on domestic goods. Global solutions are required to address the global issue of climate change. EU importers of CBAM-covered items must register with their home country’s authorities in order to get CBAM certificates. The weekly average auction price of EU ETS allowances, stated in euros per tonne of CO2 emitted, will determine the certificate’s price.

The EU has proposed to apply this tax in two phases beginning on October 1, 2023. Only requirements on reporting carbon emissions would be in effect during the three-year transitional period; no payment of the carbon border tax would be necessary. After the transition period, tax would be applied gradually from 2026 to 2034 to a variety of items. All materials and items brought into the EU will have CBAM’s applicability by 2034.

CBAM will initially apply to specific products within the sectors with the highest carbon emissions, including aluminum, iron and steel, cement, fertilizers, and power. Additionally, it will contain a few precursors and a few downstream products. Only indirect emissions for cement and fertilizers will be taken into account. To gradually integrate all goods covered by the EU ETS, including indirect emissions and emissions from international transportation, by 2030, the European Commission is required by the CBAM Regulation to set a schedule.

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Why India should be concerned

  • A sizable portion of India’s exports to the EU are likely to be impacted by the CBAM’s implementation. In reality, according to the UNCTAD, India will lose $1-1.7 billion in exports of goods like steel and aluminum that require a lot of energy.
  • Exports of aluminum, iron, and steel appear to be most at risk. The CBAM will raise compliance costs by requiring businesses to monitor, calculate, report, and verify emissions, in addition to the actual amount of the “carbon border tax” itself.
  • As coal makes up the majority of global energy use, Indian products have a substantially greater carbon intensity than those from the EU and many other nations. According to the coal ministry, India’s share of coal-fired electricity is close to 75%, which is far greater than the EU’s (15%) and the world average’s (36%). Because increasing emissions would result in higher carbon tariffs to be paid to the EU, direct and indirect emissions from iron, steel, and aluminum are a key worry for India.

Risk of domino effect

  • With nations like Australia and the US already considering such measures, the CBAM also runs the risk of starting a domino effect that might lead to the widespread adoption of carbon border regulations.
  • With the introduction of a Green Credit Programme under the Energy Conservation Act, as announced by the finance minister in this year’s Budget, India has also made the first moves towards addressing such trade-related environmental measures. Even if the Green Credit System is still not apparent at this point, India might use it as a springboard to address policies like the CBAM.
  • As of right now, the CBAM allows importers to deduct the charge (in the form of CBAM certificates) that will be incurred from the embedded emissions that are subject to a carbon price in the nation of origin. Therefore, the adoption of the Green Credit System in India may partially offset the financial effects of the CBAM.
  • Additionally, the proposed rule exempts imports from specific third-party nations from the CBAM. Only third world nations who are signatories to agreements linking their domestic emissions trading systems to the EU ETS or that are subject to the EU ETS will be given exemptions.
  • India may think about using the ongoing India-EU Free Trade Agreement’s negotiation platforms to bring up CBAM-related concerns including equivalence, mutual recognition, and exemption.
  • Insofar as these taxes and/or abatement costs are passed through to the prices while maintaining profits, the immediate economic impact of CBAM will be price rises for the targeted commodities in the EU, at least in the early phases.
  • Through forward and backward linkages, this would have an influence on the entire economy, resulting in a decline in demand for not only these goods but also for others. Despite having significantly lower per capita emissions, these downturns could have a significant impact on the economies of the less developed nations. This could also indicate a trade shift of exports from India and many other developing nations away from the EU and towards other nations, creating an excess supply situation and lowering the price of these commodities globally.
  • Longer future, however, may see many nations begin to follow CBAM-related rules to the point where the marginal cost converges to zero.

Indian exports to the EU market as a result of CBAM: Effects and mitigation measures

India’s exports of energy-intensive goods including steel, aluminum, cement, and fertilizers are anticipated to suffer significantly from the EU’s implementation of the CBAM. In the EU market, Indian exporters are expected to see higher pricing, decreased competitiveness, and decreased demand for their products.

The steel industry, which accounts for roughly 8% of world emissions, is seen as a difficult sector to regulate. According to the International Energy Agency (IEA), the iron and steel industry has produced more carbon emissions during the previous ten years, primarily as a result of rising steel demand and the energy needed to produce it.

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An extensive difficulty is anticipated for India’s metal industry as a result of the CBAM’s implementation, according to a recent analysis by the Global Trade Research Initiative (GTRI). India exported iron, steel, and aluminum goods worth $8.2 billion to the EU in 2022, or 27% of total exports. Beginning January 1, 2026, the EU will start collecting a carbon tax on each shipment of steel and aluminum. As a result, Indian businesses will be required to pay a sum corresponding to 20–35 percent of tariffs.

Lack of an emissions trading scheme similar to the EU’s ETS is one of India’s biggest problems. Without an ETS, it could be challenging for Indian companies to prove that their products are made with low-carbon technology, which would lead to higher CBAM fees.

India needs to put in place a carbon pricing mechanism, develop low-carbon technologies, and maintain its competitiveness in the global market while reducing the effects of CBAM. This will assist Indian companies in adhering to CBAM rules and lowering the carbon intensity of their products. India must also reevaluate its export strategy and find new markets for its goods in order to maintain their competitiveness in the face of CBAM’s effects on the EU market.

Measures for Indian government to minimize the impact of CBT

On the domestic front, the government has programs like the National Steel Policy and the Production Linked Incentive scheme that aim to increase India’s production capacity. However, carbon efficiency has not been one of the goals of these programs; instead, the government can add a decarbonization principle to these programs to make them more effective.

India has also made attempts to minimize emissions, such as imposing a GST compensation on coal to deter people from using it to produce electricity. The CBAM stipulates that for exemptions or reductions, a carbon price must be explicitly set; however, this method does not do so. Therefore, India should encourage the EU to consider India’s energy tariffs equivalent to the price of carbon in order to obtain tax reductions on the global front through bilateral negotiations with the EU.

In order to help reduce its carbon footprint, India should also engage with the EU to transfer sustainable technologies and finance frameworks. One option to raise money is to ask the EU to reserve a portion of their CBAM revenue towards assisting India in meeting its climate commitments. India could also start preparing for the new system, as China and Russia are doing, by building a carbon trading system, in addition to denouncing the current one.

India should therefore either establish a carbon trading system akin to the ETS or modify our current mechanisms to be in line with the ETS in order to ensure that India is not negatively impacted by the shifting environment dominated by such protectionist climate policies implemented by other nations. India should also improve its capability for measuring and monitoring emissions at the same time. India should also serve as a role model for the SAARC nations by encouraging more trade between them in order to create a new market for their carbon-intensive commodities.

Additionally, India is building the groundwork for the development of a carbon market. In this context, on March 27, 2023, the Ministry of Power released a draft of the Carbon Credits Trading Scheme (CCTS). The draft thoroughly describes the institutional setup and administrative processes that would control the upcoming carbon credit market in India. In more recent news, it was revealed that India has formally contacted the EU to ask for formal recognition of its domestic carbon credit trading programme after it had been completed.

The Indian government is also considering a number of countermeasures to the potential effects of the EU’s carbon border tax, including:

The Indian government is also considering a number of countermeasures to the potential effects of the EU’s carbon border tax, including:

  • Exchanges with the EU.
  • Creating a system for pricing carbon.
  • Encouraging use of renewable energy.
  • Purchasing carbon capture equipment.

References:

About the Contributor – Anusuya Choudhary is a research intern at IMPRI completed her bachelors in B.Sc. Economics from NMIMS university.

Acknowledgement – The author would like to thank Dr Arjun Kumar, Ms. Vaishali Singh, Dhurv Tapadia and Ms. Ronjinee who helped me throughout this article and reviewing the same.

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