Carbon border tax and Indian industries illustrated

Finance Minister Nirmala Sitharaman recently raised the prospect of “climate tariff barriers” as an imminent expense, only days after European Union (EU) members agreed to adopt the Carbon Border Adjustment Mechanism (CBAM). Sarthak Ray examines the EU’s campaign for CBAM and its consequences for India.

The mechanism for adjusting the carbon boundary (CBAM)
In July of last year, the European Commission adopted the CBAM as one of the measures to assist the EU in reducing emissions by 55% from 1990 levels by 2030. The CBAM is a tax on imported iron and steel, power, cement, aluminum, and fertilizer. Under the CBAM, EU importers will be required to purchase carbon credits equal to the carbon price that would have been paid if the products had been manufactured by the EU’s carbon pricing laws.

If a non-EU producer has previously paid for the emission in the nation where the production occurred, the EU importer can subtract this from their CBAM responsibility. The reporting system will go into effect in 2023, and the levy will go into effect in January 2026.

Why is the CBAM being implemented by the EU?
The EU argues that while other countries’ climate policies remain “less strict,” there is a risk of “carbon leakage,” in which EU-based enterprises relocate emission-intensive production to jurisdictions with looser regulations, or EU products are replaced by cheaper but more carbon-intensive imports. The CBAM, therefore, is a “price equalizer”. It is also viewed as an alternative for free permits under the EU’s Emissions Trading System (ETS), which reduces leakage but does not incentivize green manufacturing within the EU.

However, some non-EU nations see this as green action disguised as protectionism. Another school of thought is that the EU will use the CBAM as “a tool to enforce carbon pricing worldwide,” rather than acting as a lone wolf and risking trade retaliation. The EU also sees the CBAM as a source of money for its budget.

Other types of green walls
In the United States, California has implemented an emission border adjustment system that holds electricity importers responsible for emissions generated in the state from which they import power. In its Plan for a Clean Energy Revolution and Environmental Justice, the Biden administration considers carbon border adjustment. Canada and Japan are also developing their systems.

India’s stand
At COP27, India, along with China, Brazil, and South Africa, argued against carbon border levies. This organization has claimed such levies might “result in market distortion” and “aggravate the trust gap among the Parties”. Developing countries claim that the CBAM places the weight of climate action on them, even though wealthier countries have contributed the most to global warming. However, the FM’s most recent discussion with business implies that India is considering steps to assist Indian exporters to the EU in lowering such costs.

What does this entail for countries that sell to the EU, notably India?

The EU claims that the CBAM is WTO-compliant, but numerous nations are considering filing a challenge with the global trade regulator. According to a Rabobank study from 2021, India, Russia, Ukraine, Turkey, and China are among the nations that might be most affected by the shift.

India exports around $2 billion in products to the EU each year, which would be subject to the CBAM charge. The majority of it is in the iron and steel sector, with the remainder in aluminum. Almost 35% of India’s exports that would be subject to the CBAM charge are to the EU. While the UK and China have a large exposure, the presence of their national carbon markets allows EU importers to offset a portion of the CBAM charge for purchases from producers in these countries.

Only three of the top twelve CBAM exporters to the EU have emission trading mechanisms in place. Because its ETS is similar to the EU’s, the UK is expected to receive a full exemption. (The European Commission will tie the CBAM to its ETS so that its price matches the average weekly price of ETS auctions.) It remains to be seen if India, even if it implements its carbon price program, would be able to compete for significant exemptions.

* $2 billion in CBAM exports from India to the EU

* CBAM exports from India to the EU account for 35% of overall CBAM exports.

* The EU CBAM reporting deadline is 2023.

* The enforcement deadline is 2026.

RABOBANK, EC are the sources.

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