Unilateral carbon pricing

India needs to work on carbon border tariffs

The European Union has reached an agreement on the Carbon Border Adjustment Mechanism or CBAM, which it defines as a “tool to put a fair price on the carbon emitted during the production of carbon-intensive goods that are entering the EU” and which many other countries define as a carbon border tariff. The CBAM will impose a carbon price on the “embedded” emissions in goods that enter the EU. It is the first such unilateral measure attempting to force carbon pricing into the international trading system, but it is unlikely to be the last. India has traditionally opposed attempts to link the environment to trade, given the long history of western countries using labour and environmental standards as indirect tariff barriers. Yet, given the urgency of climate change, it is not surprising that this is beginning to be viewed as a losing battle.

Can the CBAM be successfully challenged at the World Trade Organization (WTO)? Many are hopeful that this will be the case. However, this underestimates the cleverness of the device, which has been designed to ensure that companies or traders are not discriminated against based on their location or the origin of the trade, but merely on the basis of the technical environmental standards they apply to their supply chain. Further, the WTO dispute resolution mechanism has been broken for some time. The United States has yet to nominate judges to the appellate tribunal of the WTO, which means the final solution to trade disputes cannot be expected from the WTO in a timely manner.

The CBAM’s implications for Indian industry are as yet only imperfectly understood. Union Finance Minister Nirmala Sitharaman recently warned the private sector in India that they would increasingly face non-tariff barriers unless they put some effort into, in her words, “quickly resetting yourselves”. The minister also called for pro-active effort from industry in identifying ways in which the burden of CBAM and similar measures could be reduced. The initial sectors to be affected by the carbon border tariff are cement, iron and steel, aluminium, fertilisers, electricity, and hydrogen. It is important to note that some of these sectors in India have large multinational players that are capable of decarbonisation to a global standard. The immediate impact on small and medium enterprises or labour-intensive exports is therefore not likely to be vast.

Even so, the government and industry must respond to Ms Sitharaman’s call. Merely complaining about CBAM or hoping that the WTO will strike it down severely misses the point. The next step is to understand if and how India can take advantage of the CBAM. The country is, after all, in the throes of negotiating its trading relationship with the EU, and the question of a gradual adjustment to the CBAM must be on the table. For this, some internal reforms will be necessary. India has more than one internal carbon trading mechanism, but none satisfactory or helping prepare sectors for global carbon tariffs. India should also consider the opportunities being opened up by proposals such as the Group of Seven nations’ “climate club” idea, which creates slightly different linkages between trade relationships and embedded carbon.