On the face of it, many Mandarins bristle and retort that India may well resort to retaliatory taxes if EU’s plans to kick in a Carbon Border Adjustment Mechanism (CBAM) from the new year are implemented.

However, at the same time, bureaucrats and political leaders who work on trade and fiscal policies in New Delhi reveal that they are working feverishly on a solution, which could mean a domestic levy on high carbon intensive industries like steel, iron and aluminium. This could be equal to EU’s proposed carbon tax and the money raised is used for green energy transition to which India is committed.

EU’s Carbon Tax

The EU has announced carbon tax could be levied on carbon-intensive imports from seven sectors – including steel, cement, fertiliser, aluminium and hydrocarbon products – from January 1, 2026. At stake is not just trade with the European Union. Similar taxes may well be brought in by other western nation’s who together account for most of India’s exports.

“Bharat will address the problem of CBAM with confidence, and we will find solutions. We will see how we can convert CBAM to our advantage if it comes in," India’s Commerce and Industry Piyush Goyal said at an industry chamber event last week in New Delhi, adding in the same breath that India may retaliate if needed.

India exported some US$ 74 billion worth of goods to the European Union in the fiscal year 2022-23, which also became the top finished steel export destination for Indian steelmakers during the fiscal year gone-by.

However, inflation has been increasing and was 5.5 per cent in November this year, up from 4.8 per cent in October. Any levy on what the Indian industry calls “core goods” like steel and aluminium, which are used to make many more goods, could end up causing an inflationary spiral.

Not exactly a happy situation in an election year where the ruling BJP-led NDA will be facing a challenge from the newly put together INDIA bloc of opposition parties.

Indian Green Response

“Since mitigation measures are needed a carbon tax cannot be ruled out, but this is the election season and a tax on core products would push up inflation … at this stage that would perhaps not be advisable,” said Sumit Dutt Majumder, former chairman of Central Board of Excise and Customs, now renamed as Central Board of Indirect Taxes and Customs.

Dutt Majumder, whose book on GST is considered a seminal work by many tax practitioners, believes innovative measures can still be thought out by dedicating certain taxes towards existing moves towards a greener economy.

Moving away from fossil fuels has been a problem for India. Nearly 75 per of its energy needs are based on fossil fuel and 25 per cent of the central government’s revenues come from taxing fossil fuel.

Though the government is expanding its renewable energy capacity at a hectic pace of 50GW a year, which is among the fastest in the world and aims to achieve a 45 per cent cut in emissions by 2030. Last year’s Union Budget had earmarked ‘Green Growth’ as one of its seven priorities. Officials said this year’s budget is expected to increase the emphasis on “greening industry”.

Already the state is looking at fiscal carrot-and-stick policies which would force industry to move towards greener technologies and “these will certainly come into play in this budget,” said a top official of India’s Finance Ministry.

Officials point out that the commonly used fiscal policy measures to “green an economy” include carbon taxes, emission trading, capping emission levels, levelling fees on emissions beyond a certain level and incentives on green transition by industry.

“We can expect a cocktail of these to be present in the coming budget,” another official said.

Retaliation?

However, this government which has won most of its elections on a ‘nationalistic’ plank can also not afford to show that it buckled under pressure.

“The West has no business preaching to us on pollution, they have been the biggest polluters historically. Yes, we will of course take measures to mitigate (but) … There can be retaliatory measures if such non-tariff barriers are brought in,” Ashwani Mahajan, National Co-Convener of Swadeshi Jagaran Manch, whose right-wing ideological thought does at times influence the ruling party’s policy-making.

At the same time retaliatory measures may be difficult to implement as India is also looking at wrapping up a free trade pact with the European Union. However, the coveted FTA, which both sides have long been haggling over, may also be affected if the EU becomes a stickler for rules on carbon taxation, hitting Indian industry.

“Imposition of retaliatory tariffs may not be in the best interests of India since the government is looking for an early conclusion of the long-awaited bilateral free trade agreement with the EU,” said Prof. Biswajit Dhar, formerly the director general of RIS and a trade expert.

However, on a technical issue, the attempt to pass off India's domestic taxes as mitigation measures too may also fall short.

Dhar pointed out, “The EU is unlikely to accept the argument that India is imposing taxes on fossil fuels, as the basis for its proposed CBAM is entirely different. The EU argues that the emission levels of its own industries are capped, and that they have to incur an expenditure for keeping their emissions below the cap. Such an expenditure is not borne by the industries from which EU imports, and consequently, EU-based industries suffer from a competitive disadvantage. The CBAM is intended to neutralise this inherent disadvantage.”