On carbon burden, Europe’s glaring hypocrisy.

Current Situation:

The European Union’s (EU) recent announcement of a gradual implementation of the carbon border adjustment mechanism (CBAM) is viewed as a resurgence of frictions in an inherently unequal trading system.
The CBAM is not separate from the EU’s attempts at mitigating the effects of climate change that include an emission trading system used to price emissions.

Issues associated :

In the early phases, plenty of exemptions in the trading system undermined its efficacy.
As the EU ramps up its efforts to withdraw free allowances in the system, there is a worry that businesses will relocate to jurisdictions with no such comparable regulations.
Carbon leakage has compelled the EU to supplement its “Fit for 55 Agenda” with a levy on imports from countries that do not price carbon.
Developing countries are taking notice of this development as it kicks in this October.
CBAM raises more serious concerns on the structure of the manufacturing sector that will be dominated by companies and countries that are able to withstand the winds of change.

What is CBAM?

After several months of negotiations, the European Parliament and EU Council have reached a historic agreement on Carbon Border Adjustment Mechanism (CBAM) that will apply to the import of certain product groups to the EU starting October 1, 2023.
CBAM is one of the elements of the EU Green Deal, the goal of which is to reduce GHG emissions by 55% by 2030. CBAM is aimed at equalizing the price of carbon paid for EU products operating under the EU Emissions Trading System (ETS) and imported goods.
During the transitional phase of CBAM there will only be a requirement for the quarterly reporting of the greenhouse gas footprint of certain products imported to the EU (including direct and indirect emissions).
Starting 2026, there will also be a requirement to purchase CBAM certificates to cover the GHG footprint, and the price of CBAM certificates would be linked to carbon prices at the EU ETS.
CBAM would represent an additional cost related to export to the EU market, which would in the end of the day be shared with the exporter or producer and could influence their marketing strategy. There are expectations that other countries may also implement measures similar to CBAM.

Implementation:

The CBAM will be implemented by requiring importers to declare the quantity of goods imported into the EU and their embedded Greenhouse Gas (GHG) emissions on an annual basis.
To offset these emissions, importers will need to surrender a corresponding number of CBAM certificates, the price of which will be based on the weekly average auction price of EU Emission Trading System (ETS) allowances in €/tonne of CO2 emitted.

Objectives:

CBAM will ensure its climate objectives are not undermined by carbon-intensive imports and spur cleaner production in the rest of the world.

Significance:

It can encourage non-EU countries to adopt more stringent environmental regulations, which would reduce global carbon emissions.
It can prevent carbon leakage by discouraging companies from relocating to countries with weaker environmental regulations.
The revenue generated from CBAM will be used to support EU climate policies, which can be learned by other countries to support Green Energy.

Impact of CBAM on trade and commerce between EU and other countries:

The EU is an important trading partner. Even though its regional trade is significant, the composition of trade in specific commodities and services is not EU dominated. For example, Turkey, Russia, South Korea, India and China are the top five sources of steel imports for the EU.
Similarly, Russia and Mozambique account for 50 per cent of its aluminum imports. Both these products along with cement, fertilizer, electricity and hydrogen will be covered under the initial phase of the CBAM.
The worry is this will significantly impact trade with countries such as India that depend on the EU for its exports — 26.4 per cent of India’s exports of products are potentially covered by CBAM.

The possible outcomes due to rise in taxation under CBAM:

It is possible that the EU may end up losing on account of higher input costs as they may be passed on to consumers.
Steel and aluminum are crucial not just for its major exports such as vehicles but also for green transition (aluminum).
CBAM will apply to aluminum even as the EU lists it as a critical mineral and struggles to lift its production.
It is hard to reconcile these with the application of a tariff on imports except for the reason that CBAM is designed to keep countries such as China —suppliers of minerals out of the EU. A similar approach was adopted in the past to protect smelters.

How should India respond to this tax?

There is the WTO to contest the measure as discriminatory. However, CBAM raises more serious concerns on the structure of the manufacturing sector that will be dominated by companies and countries that are able to withstand the winds of change.
The EU and the US have responded to the challenge by designing incentive schemes to attract investments and to remain competitive.
India too may have to innovate. With limited fiscal space, an internal carbon market along with an effective taxing mechanism may not only nudge firms in that direction, but also can support consumers and smaller businesses
Such pricing mechanisms can also work as a tool to negotiate equivalence with the CBAM, as common but differentiated responsibility would mean that India can price carbon differently as per its level of development.

Conclusion:

CBAM is significant imitative of EU to check on carbon emission during manufacturing services and trade & commerce which will help in countering climate change
However, there is need that India must respond with a policy that ensures pricing of carbon in line with its development priorities.
It’s high time that India has to innovate its pricing policy to counter EU’s carbon tax.

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