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The EU intends to go carbon-neutral by 2050, with a net-zero-emission economy that keeps greenhouse gases released and removed from the atmosphere in balance. At the forefront of sustainability, the EU not only introduced carbon-rights trading, but also a Carbon Border Adjusted Mechanism (CBAM), a policy measure to mitigate carbon-related regulatory arbitrage associated with international trade. This is primarily aimed at reducing the price gap between imported goods from less stringent emission regimes and its domestic produce, creating a level playing field by placing a kind of environmental ‘tax’ on imports. The CBAM proposal expects it to be functional by 2026 and projects it as a tool to prevent “carbon leakage" and “reduce greenhouse gases" by subjecting imported goods to levies based on carbon-cost equivalents under the EU’s Emission Trading System (ETS) that applies to domestic production. The mechanism is declarative in nature, whereby an authorized declarant importing goods from outside the bloc has to declare the emissions embedded in the consignment and surrender a corresponding quantum of CBAM certificates, which will be modelled on ETS allowances (or carbon rights). If a carbon price has already been paid in other jurisdictions, then equivalent deductions are allowed. However, the price of CBAM certificates in the territory would be based on weekly average auction prices of ETS allowances. Alternatively, default emission levels based on the average of an exporting country can be declared. The proposed regulation would initially apply to goods imported from sectors such as iron and steel, aluminium, fertilizers, electricity and cement, originating in any third country except for Iceland, Liechtenstein, Norway and Switzerland, as these countries are under the EU’s ETS coverage.

Over the past 150 years, the EU has accounted for about 40% of the world’s carbon emissions, while countries like ours contributed just 2%. The EU’s pledges, hence, are a cause of concern for developing nations like India. With 14% of India’s exports going to EU countries, the CBAM could put Indian exporters in a spot. Almost 25% of the EU’s iron and steel imports currently come from countries that will take a CBAM rap, a figure that could drop should EU demand shift in favour of suppliers within the bloc, in turn hampering trade ties with India. Exports of iron and steel and aluminium products from India to the EU were around $4 billion and $500 million, respectively, in 2020-21.

The proposed measures seem detrimental to Indian imports as well. The additional cost of CBAM certificates for goods imported by the EU may distort prices of these goods in downstream industries, affecting the competitiveness of sectors like automobiles, electrical goods, machinery and equipment. Importers in the region are faced with an estimated extra €9 billion in carbon costs every year once the CBAM kicks in. At present, the bloc’s share in global exports of automobiles and machinery and electrical sectors stand at 45% and 25%, respectively. These final goods from the EU can be substituted by Indian-made products, or could result in dependence on countries like China, adding to our worries of a trade imbalance with the Asian giant.

So far, the EU has been concerned about the relocation of carbon-intensive industries to countries with less stringent carbon-mitigation regulations. However, higher input-cost pressures may tempt downstream sectors to relocate outside the Union. This would create magnificent opportunities for India’s growth-seeking industrial sector, backed by policy support for a business environment that lets industries flourish.

While we may have to wait for the CBAM mechanism to become operational in 2026 for us to assess its full implications, we must prepare for it well in time. Of the five initial sectors under the EU’s new regulation, iron and steel appears to be the most vulnerable, given that the carbon-emission intensity of Indian steel plants is currently in the range of 2.3-2.8 tonnes for every tonne of crude steel produced, higher than the world average of just 1.8 tonnes (as per the World Steel Organization). India’s Intended Nationally Determined Contributions under the 2015 Paris Agreement aim at reducing this sector’s carbon intensity to 2.4 tonnes by 2030, down from 3.1 tonnes in 2005, and the industry is on track for that. Although about half of India’s iron and steel production is done via electric method, which emits less carbon than the traditional oxygen furnace, emissions embedded in the use of coal for energy is still a concern. A more fail-safe approach for the world’s second largest steel producing nation would be to become carbon competitive in the medium to long run, by moving aggressively towards sustainable production. A trade deal with the EU that takes into consideration the principle of “common but differentiated responsibilities" under the Paris pact may open some space for a combined but fair contribution to the cause of carbon reduction. A trade deal is imminent and will buy time for India to bring down emissions to desired levels.

Developed markets like the EU should consider forging technology partnerships with manufacturers in regions like ours. This will help minimize perceptions in emerging markets of carbon-control tools serving as devices for trade protectionism.

Sure, sustainability demands incremental improvements. But enforcing jerky transitions could leave all of us worse off.

Ritika Bansal & Jatin Grover are, respectively, an Indian Economic Service officer, and a senior financial consultant

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