Carbon border adjustment mechanism

General Studies Paper 3

Context: The European Union (EU) has announced that its Carbon Border Adjustment Mechanism (CBAM) will be introduced in its transitional phase from October 2023, which will levy a carbon tax on imports of products made from the processes which are not Environmentally sustainable or non-Green. CBAM will translate into a 20-35 % tax on select imports into the EU starting 1st January 2026.

What is CBAM?

CBAM is part of the “Fit for 55 in 2030 package”, which is the EU’s plan to reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels in line with the European Climate Law.

The CBAM is a policy tool aimed at reducing Carbon Emissions by ensuring that imported goods are subject to the same carbon costs as products produced within the EU.

Implementation:

• The CBAM will be implemented by requiring importers to declare the quantity of goods imported into the EU and their embedded Greenhouse Gas (GHG) emissions on an annual basis.
• To offset these emissions, importers will need to surrender a corresponding number of CBAM certificates, the price of which will be based on the weekly average auction price of EU Emission Trading System (ETS) allowances in €/tonne of CO2 emitted.
• Objectives: CBAM will ensure its climate objectives are not undermined by carbon-intensive imports and spur cleaner production in the rest of the world.

Significance:

• It can encourage non-EU countries to adopt more stringent environmental regulations, which would reduce global carbon emissions.
• It can prevent carbon leakage by discouraging companies from relocating to countries with weaker environmental regulations.
• The revenue generated from CBAM will be used to support EU climate policies, which can be learned by other countries to support Green Energy.

How can it Impact India?

Impact India’s Export: It will have an adverse impact on India’s exports of metals such as Iron, Steel and aluminum products to the EU, because these will face extra scrutiny under the mechanism.

• India’s major exports to the EU, such as iron ore and steel, face a significant threat due to the carbon levies ranging from 19.8% to 52.7%.
• From 1st January 2026, the EU will start collecting the carbon tax on each consignment of steel, aluminum, cement, fertilizer, hydrogen and electricity.

Carbon Intensity and Higher Tariffs:

• The carbon intensity of Indian products is significantly higher than that of the EU and many other countries because coal dominates the overall energy consumption.
• The proportion of coal-fired power in India is close to 75%, which is much higher than the EU (15%) and the global average (36%).
• Therefore, direct and indirect emissions from iron and steel and aluminium are a major concern for India as higher emissions would translate to higher carbon tariffs to be paid to the EU.

Risk to Export Competitiveness:

• It will initially affect a few sectors but may expand to other sectors in the future, such as refined petroleum products, organic chemicals, pharma medicaments, and textiles, which are among the top 20 goods imported from India by the EU.
• Since India has no domestic carbon pricing scheme in place, this poses a greater risk to export competitiveness, as other countries with a carbon pricing system in place might have to pay less carbon tax or get exemptions.

What Measures can India Take to Mitigate the Impact of CBAM?

Decarbonization Principle:

• On the domestic front, the government has schemes like National Steel Policy, and the Production Linked Incentive (PLI) scheme aims to increase India’s production capacity, but carbon efficiency has been out of the objectives of such schemes.
• The government can complement these schemes with a Decarbonization Principle.
• Decarbonization refers to the process of reducing or eliminating greenhouse gas emissions, especially carbon dioxide (CO2), from human activities such as transportation, power generation, manufacturing, and agriculture.

Negotiation with EU for Tax Reduction:

• India could negotiate with the EU to recognize its energy taxes as equivalent to a carbon price, which would make its exports less susceptible to CBAM.
• For example, India could argue that its tax on coal is a measure to internalize the costs of carbon emissions, and therefore equivalent to a carbon tax.

Transfer of Clean Technologies:

• India should negotiate with the EU to transfer clean technologies and financing mechanisms to aid in making India’s production sector more carbon efficient.
• One way to finance this is to propose to the EU to set aside a portion of their CBAM revenue for supporting India’s climate commitments.
• Besides, India should also begin preparing for the new system just as China and Russia are doing by establishing a Carbon Trading System.

Incentivizing Greener Production:

• India can begin preparations and in fact, seize the opportunity to make production greener and sustainable by incentivizing cleaner production which will benefit India in both remaining competitive in a more carbon-conscious future.
• International economic system and achieving its 2070 Net Zero Targets without compromising on its developmental goals and economic aspirations.

Take on EU’s Tax Framework:

• India, as the leader of the G-20 2023, should use its position to advocate for other countries and urge them to oppose the EU’s carbon tax framework.
• India should not only focus on its own interests but also consider the negative impact that the CBAM will have on poorer countries that heavily rely on mineral resources.

Conclusion

• The CBAM is a policy to reduce carbon emissions from imported goods and create a fair-trade environment.
• It can encourage other countries to have stricter environmental regulations and reduce global carbon emissions