EU’s carbon border adjustment mechanism

Environment and Ecology Envirnment and Climate Change

Context: Recently, the co-legislators at the European Commission signed the Carbon Border Adjustment Mechanism (CBAM).

The regulation will put a fair price on carbon emitted during the production of carbon intensive goods entering the EU and encourage cleaner industrial production in non-EU countries.
Importers will start paying the financial levy from 2026.

CBAM has been described as a landmark tool to put a fair price on the carbon emitted during the production of carbon-intensive goods that are entering the EU and to encourage cleaner industrial production in non-EU countries.
Objective: Its primary objective is to avert ‘carbon leakage’. Carbon leakage occurs when companies based in the EU move carbon-intensive production abroad to countries where less stringent climate policies are in place than in the EU or when EU products get replaced by more carbon-intensive imports.
Key Provisions: From 2026, once the CBAM is fully implemented, importers in the EU would have to buy carbon certificates corresponding to the payable carbon price of the import had the product been produced in the EU under its carbon pricing rules.
Conversely, if a non-EU producer is paying a price (or tax) for carbon used to produce the imported goods, back home or in some other country, the corresponding cost would be deducted for the EU importer.
Importers would have to annually declare by May-end the quantity and embedded emissions in the goods imported into the region in the preceding year.
Sectors covered: CBAM would initially apply to imports of certain goods and selected precursors, whose production is carbon-intensive and are at risk of ‘leakage’ such as the cement, iron and steel, aluminium, fertilizers, electricity and hydrogen sectors.

In 2021, the United Nations Conference on Trade and Development (UNCTAD) had concluded that Russia, China and Turkey were most exposed to the mechanism.
India, Brazil and South Africa would be most affected among the developing countries. Mozambique would be the most exposed least-developing country.
Note: EU as a whole represents about 14% of India’s export mix for all products, steel and aluminium included.

India’s exports in the five segments covered under CBAM represent less than 2% of the total exports to the EU between 2019 and 2021. However, its long-term effects can be severe for multiple factors:
Firstly, the EU being India’s third-largest trade partner and given the latter’s projected growth trajectories, the size of exports (including in the CBAM sectors) will invariably rise.
Secondly, CBAM’s scope would expand beyond its current ambit to include other sectors as well.
Thirdly, international climate policies (including CBAM) will compel other countries to impose similar regulations eventually translating to “a significant impact” on India’s trading relationships and balance of payments.