EU’s Carbon Border Adjustment Mechanism (CBAM)

Economic Affairs Foreign Trade - Trends and Policy

Context: The Minister of Commerce and Industry has said that the CBAM is “unfair” as carbon could not be priced the same in India and Europe.

As part of a plan to decarbonize its economy by 2050, the European Union introduced a carbon border adjustment mechanism (CBAM).
It is a duty on imports based on the amount of carbon emissions resulting from the production of the product in question.
Its primary objective is to avert ‘carbon leakage’. It refers to a phenomenon where a EU manufacturer moves carbon-intensive production to countries outside the region with less stringent climate policies.
In other words, replace EU-manufactured products with more carbon-intensive imports.

The idea here is to avert the possibility of carbon leakage alongside encouraging producers in non-EU countries to green their manufacturing processes.
To ensure a level playing field between imports and EU products.
This would also form part of the continent’s broader European Green Deal which endeavours to achieve 55% reduction in carbon emissions compared to 1990 levels by 2030 and become a climate neutral continent by 2050.

On 1 October 2023, the CBAM entered into application in its transitional phase, with the first reporting period for importers ending 31 January 2024.
The CBAM will initially apply to imports of certain goods and selected precursors whose production is carbon intensive and at most significant risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen.

Acting as a trade barrier: With the CBAM in effect from 1 October, India’s exports of carbon-laden products to Europe—mainly aluminium and iron-and-steel—have been burdened with green reporting rules which is a trade barrier in itself.
Uncompetitive exports: India’s products have a higher carbon intensity than its European counterparts, the carbon tariffs imposed will be proportionally higher making Indian exports substantially uncompetitive.
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.
May push for similar regulations worldwide: International climate policies (including CBAM) will compel other countries to impose similar regulation eventually translating to ‘a significant impact’ on India’s trading relationships and balance of payments.

In terms of carbon intensity, the carbon intensity of Indian products is significantly higher than that of the EU and many other countries.
This is because coal dominates the overall energy consumption. Hence, higher emissions would translate to higher carbon tariffs to be paid to the EU.
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%).
Moreover, India has no domestic carbon pricing scheme in place which poses a greater risk to export competitiveness.
Other countries with such a system in place might have to pay less carbon tax or get exemptions.

Transparency and non-discrimination should remain key principles of any global understanding, and that should also ensure that carbon-related measures do not unnecessarily restrict trade.
It remains to be seen, however, to what degree the CBAM will succeed in incentivizing deeper decarbonization and whether it will spur a virtuous policy cycle among global trading partners or, on the contrary, if it will start another round of trade wars.