India’s Export Thrust May Face A Carbon Challenge As Impact Of EU Carbon Tariff Rules Loom Large

CBAM is akin to a tax on the carbon emitted during the process of producing imported carbon-intensive goods. The objective of this mechanism is to ensure that the carbon price of imported products is equivalent to the carbon price of producing similar products in the EU.

While adopting CBAM, the EU became the first political entity to have applied its domestic carbon price to carbon emissions generated outside its borders.

The CBAM has been in the works since the EU took steps to reduce emissions of greenhouse gases more than two decades ago through the establishment of a carbon market. In 2003, the Emissions Trading Scheme (ETS) was introduced, which works on the ‘cap and trade’ principle.

Under this Scheme, a cap is introduced on the overall amount of greenhouse gases that can be emitted, and the cap is gradually reduced so that emissions decrease over time.

The ETS covers carbon dioxide emissions from power stations, energy-intensive heavy industries, and civil aviation and from this year the system will be extended to cover emissions from maritime transport as well.

Ever since the EU members adopted the ETS, they have been discussing ways of applying border measures on imports from countries not implementing comparable reductions in carbon emissions, which, in their view, is causing the problem of ‘carbon leakage’.

Carbon leakage may occur if businesses transfer their production facilities to countries having low levels of regulations on carbon emissions. In other words, this can create ‘carbon havens’ in non-carbon-constrained countries.

Level Playing Field? 

EU members have long argued that the carbon costs imposed by their domestic climate policies, including the cap-and-trade scheme, had put their own producers at a competitive disadvantage vis-à-vis producers in countries not imposing limits on emissions.

The CBAM is, thus, being viewed as a major step to introduce a level playing field between the EU-based producers and their counterparts from those countries that have not implemented emissions reduction measures.

EU members have identified six sectors whose production is carbon intensive, and which also have significant risks of carbon leakage.

These are cement, iron and steel, aluminium, fertiliser, electricity, and hydrogen.

However the countries which are affected may not agree with it as leveller as they are from a different level of development where to increase output and wean people away from unproductive farms they would need to rely on more carbon-intensive factories.

The CBAM is being implemented from 1st October 2023, though the carbon tax to be applied under this mechanism will become effective from the beginning of 2026.

During the initial transition period, namely the period up to the end of 2025, importers of goods produced by the targeted sectors have to report, on a quarterly basis, the volume of their imports and the greenhouse gas emissions during their production processes.

Importers were required to collect data for the fourth quarter of 2023, and submit their first report by 31 January 2024. The stringency of this requirement can be gauged from the fact that only a minority of European companies have complied with this early reporting deadline.

Red Tape & Penal Fees

However, the defaulters face a Hobson’s choice. Those who have not submitted CBAM reports by 31 July 2024 face the risk of incurring fines.

This implies that the CBAM has the potential to impact entities importing the targeted products even during the transitional period as the EU's bureaucracy has built in its own 'red tape' and penal fees into the system.

The impact of CBAM could potentially be large for India since the EU is not only the country’s largest export destination but its significance is also increasing. Between 2017-18 and 2023-24, the share of exports to the EU increased from 14.5 per cent to 17.4 per cent.

Moreover, the EU is a significant market for two of the five industries covered under the CBAM, namely, iron and steel and aluminium, and this market has grown over the past few years.

CBAM Impact On India

The EU members accounted for almost 22 per cent of India’s exports of iron and steel in 2019-20, and by 2023-24, this figure has increased to 40 per cent. Some US $ 5.5 billion worth of iron and steel was exported to EU countries and another US $ 2.4 billion worth of iron and steel fabrication were exported to the European Union.

Similarly, the share of aluminium exports to the EU increased from 8 per cent to 14 per cent during the same period.

Both these sectors could be significantly impacted after the full-fledged implementation of CBAM from 2026, particularly due to the preponderance of small and medium-sized enterprises in both these industries.

The new regulations could severely impact their competitiveness, through the increase in compliance costs and the inability of these enterprises to adapt to the new regulations quickly due to financial constraints.

Besides the products that India is currently exporting to the EU, it has considerable potential to export green hydrogen, if the industry receives adequate levels of investment.

A recent report by the data analytics firm, Alvarez and Marsal, showed that India is among the most competitive in global green hydrogen and is therefore well placed to capture a significant share of global trade by the end of the decade.

Which is possibly why Reliance is planning on a massive investment of Rs 1 lakh crore on a green hydrogen hub in Gujarat. (You may wish to read a related  story on green hydrogen industry in India)

Though the CBAM has been in place for almost a year, the response of the industry as well as the government to this challenge has been much less than desirable.

With the possibility of more countries adopting CBAM-like regulations looming in the horizon, the industry and the government urgently need a coherent and coordinated strategy in order to ensure that India’s exports are not adversely affected.

(The author is a former professor of economics at Jawaharlal Nehru University and a distinguished professor of the Council for Social Development -- a New Delhi-based think-tank. Views expressed are personal)