Jul 2, 20214 min read

Carbon tariffs needn’t impede Indian exports to the EU

The European Union (EU) stands out for its bold initiatives on preventing climate change. The EU’s Carbon Border Adjustment Mechanism (CBAM) is one such initiative for imposing additional import duties on certain products in accordance with their carbon content to discourage carbon-intensive imports.

The CBAM aims to address the issue of carbon leakage that has been EU’s concern for a long time. The underlying idea is to create a level playing field for production units in the region vis-à-vis imports from countries with ‘laxer’ environmental regulations. The EU defines carbon leakage as “the situation that may occur if, for reasons of costs related to climate policies, businesses were to transfer production to other countries with laxer emission constraints”; This could lead to an increase in their total emissions.

Under the new mechanism, exporters of energy-intensive goods to EU countries would be charged gate-money in accordance with the carbon prices applicable had they been produced within the region, in an attempt to deter producers from shifting production outside the EU and importing goods instead. As its member states are also signatories to the General Agreement on Tariffs and Trade (GATT) and World Trade Organization (WTO), it may be pertinent to examine whether the EU’s additional duties would be compatible with provisions under the GATT and WTO agreements.

Historical perspective : With the adoption of the Kyoto Protocol to the United Nations Framework Convention on Climate Change in 1997, the EU agreed to reduce emissions of a basket of six greenhouse gases by 8% from 1990 levels during the commitment period of 2008-2012. Its agile member states undertook serious deliberations and introduced the world’s first regional emission trading system, the EU-Emission Trading System (ETS). By means of the ‘cap-and-trade’ principle that EU-ETS follows, installations in all energy-intensive sectors like power , steel, cement and ceramics have to incur additional costs of pollution allowances or emission reduction. Rattled by the prospect of these industries relocating outside the region to dodge stringent rules, EU members have been mulling a new regime of carbon adjusted border mechanism.

The Paris Agreement, which came into force in November 2016, is a legally-binding international treaty on climate change adopted by 196 parties. Through this agreement, they aspired to reduce greenhouse gas emissions by developing strategies, technologies, capacity, and sources of finance for mitigation and adaptation. The CBAM would be a step in the direction of making the EU carbon-neutral by 2050, as envisaged under the Paris Agreement.

Possible implications for India: Although the manner in which CBAM would be introduced and its design have not been decided yet, it is highly probable that it would lead to an increase in existing tariffs payable on Indian exports of certain products to the EU. The CBAM would be applicable on products like paper, wood, ceramics, glass, aluminium, iron, steel and certain chemicals, which are energy-intensive and are regulated under the existing EU-ETS.

In order to assess the impact of additional tariffs by the EU on India’s exports, we have used the concept of tariff elasticities (i.e., likely change in trade flows of goods in response to tariff changes by the importing country). As of 2020, imports from India in these select products amounted to around $9 billion. Using the trade elasticity database of CPEII, a French centre for research on the world economy, for goods that are regulated under the EU-ETS and the EU’s 2020 imports from India, an elementary analysis shows that if the EU increases its tariff from, say, 10% to 10.1%, ceteris paribus, its imports from India in these sectors would decline by around $1 billion. A larger increase, say, from 10% to 10.5% may reduce imports from India by around $4.5 billion. As per the data, the impact would be colossal for aluminium, followed by iron and steel, organic chemicals and paper products.

Considering that the EU is among the biggest import destinations for Indian products, any potential increase in duties for Indian exports to the EU might hurt our domestic industry significantly.

In view of the above, it is essential that we prepare to minimize the impact of the EU’s impending decision on carbon-adjusted tariffs. This would require actions to decarbonize the Indian manufacturing sector through a two-pronged approach: expediting a transition from coal-based to renewable energy sources while ensuring its efficient usage. A number of steps are being taken by the government to switch to renewable sources.

In India, energy-intensive sectors have successfully reduced around 92 million tonnes of carbon emissions between 2012-2019 through the Perform, Achieve and Trade (PAT) scheme under the National Mission for Enhanced Energy Efficiency. PAT assigns specific energy consumption targets to ‘designated consumers’, which are installations notified under the Energy Conservation Act, 2001, and covered under the PAT scheme. The success of this scheme calls for deliberations to expand the list of designated consumers to incentivize research and investment in energy-efficient technologies and practices. Each step towards lower carbon emissions will help realize India’s targets under the Paris Agreement and make our goods ‘carbon competitive’, which can be one of the ways to avert additional duties under the CBAM.