Carbon Border Taxes: An Unfair Threat For India Or An Opportunity To Decarbonise?

By 2026, the European Union could have a carbon tax on imports of certain products manufactured using carbon-intensive energy. This would be the consequence of the adoption of a proposal in July 2021 for a Carbon Border Adjustment Mechanism by the European Commission, effectively placing a carbon price or tariff on EU imports of a selection of products. The objective is to ensure that European emissions reduction efforts contribute to a decline in global emissions, instead of moving carbon-intensive production outside the EU. It also aims to encourage industry outside the EU to adopt less carbon-intensive means of production. In its initial phase, the CBAM will apply to iron and steel and aluminium (of particular concern for India), cement, fertiliser, and electricity generation.

CBAM is likely to feature prominently at the COP26 conference in Glasgow in a few weeks’ time. Its initial announcement brought sharp criticism, with the BASIC countries (Brazil, South Africa, India, and China) in particular claiming that the proposal was ‘discriminatory’ and went against the United Nations principle of “common but differentiated responsibilities and respective capabilities”, which recognises that richer countries must provide finance and technology to developing countries to fight climate change. The ministerial statement after the BRICS environmental meeting last August said, “We noted with grave concern the proposals for introducing trade barriers, such as unilateral carbon border adjustment that are discriminatory.”

Erstwhile union environment minister Prakash Javadekar and current environment minister Bhupender Yadav have voiced similar concerns and power minister RK Singh reiterated the importance of climate equity at the UN High-Level Dialogue on Energy 2021 last month.

CBAM And The EU Emissions Trading System

The CBAM is closely related to the EU Emissions Trading System or ETS which is part of the suite of policy instruments intended to carry Europe to net-zero emissions by 2050. This cap-and-trade system has been applied to many EU firms since 2005. Under it, overall carbon emissions are capped, progressively reduced and carbon emissions rights allocated. Polluting firms purchase these rights, which are then surrendered based on carbon emitted, traded, or kept for the future. These emission allowances are reduced over time, which drives up their price, thereby incentivising firms to decarbonise.

European governments and businesses are concerned that rising carbon prices will make EU firms uncompetitive vis-à-vis firms outside the EU that are not subject to a carbon price.

They feel that this could shift carbon-emitting production offshore the EU, which would be bad both for EU businesses and the global climate.

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Climate Equity Matters

Equity concerns raised by developing countries relating to instruments such as the CBAM are valid. There is no wishing away the responsibility of rich countries for historical emissions. Even today, there are stark emissions inequalities between the developed and developing world. More sharply germane to the CBAM is the fact that some European firms get their emissions allocations under the ETS free of charge, undermining the argument that European firms are at a disadvantage as compared to firms not subject to the ETS. As recently as March this year, the European Parliament narrowly voted to retain free emissions allowances for some industries. This is a difficult position to maintain in the light of the CBAM.

And finally, there’s the 100-billion dollar question.

By any measurement, the pledge made by developed countries in Copenhagen in 2009, reaffirmed by the Paris Agreement in 2015, to provide $100 billion of climate finance a year to developing countries by 2020 has not been kept.

There is much to be fixed in the measurement and categorisation of financial flows under the rubric of climate finance, but it is clear that this has been a practical and ethical failure of the developed world.

Politics And Geopolitics

So, climate equity matters need to be addressed. At the same time, countries like India need to learn to work with the idea that pressure from the EU and others to do more on emissions reductions isn’t going away. Climate change is now a key electoral issue in many EU countries – this trend will deepen. Also, as pointed out here, taking the cue from the court of public opinion, actual courts in various EU countries are holding governments accountable to meet their own net-zero targets.

It is, therefore, reasonable to assume that the EU will go ahead with some version of the CBAM. It is also reasonable to assume that the United States, particularly under President Joe Biden, will also pivot to a position similar to Europe on carbon border taxes. Already, in the week after Europe announced the CBAM, two Democratic senators introduced legislation that would introduce a carbon tariff on certain imports like steel.

An extreme, if unlikely, scenario is that if the BRICS/BASIC countries remain recalcitrant, they run the risk of becoming an isolated alliance of carbon emitters.

Arguably, China is using the CBAM announcement as an opportunity merely to take cheap pot-shots at the west. It has a robust net-zero scheme, launched an ETS of its own earlier this year, and has pledged to peak emissions by 2030 and become carbon neutral by 2060. Whenever it feels its other geopolitical objectives will benefit from alignment with the developed world on climate, it will do so. It is not inconceivable that China will introduce a carbon border tax of its own in the future.

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Can India Turn CBAM Into An Opportunity?

India needs to think strategically of measures to protect itself from the threat of instruments such as carbon border taxes. There are positive-sum games to seek out here.

India should capitalise on the concern for climate change issues in the west to project itself as a good destination for climate finance transfers and investments, thereby providing a path to enable the developed world to fulfil its climate finance obligations. This could help it to receive a large chunk of the $100 billion earmarked for global climate finance transfers. To do so, there are several steps that India could take. Here are some of them:

Create conditions for an India-wide carbon tax

The most obvious, sustainable, long-term measure to mitigate against CBAM is for India to take the difficult steps necessary to introduce a comprehensive carbon tax of our own (not the mishmash of measures we have at the moment). This will be a complicated process and will have significant transition costs, which, if clearly mapped out, could legitimately be claimed for under climate finance transfers.

Make the power sector more investible

India also needs to take stronger policy action to make the power sector less risky for energy transition investments.

While the renewable energy sector has done reasonably well in the past decade, India only saw $6.2 billion of the $303.5 billion invested worldwide in renewable energy in 2020 (China was at $83.6 billion).

Ultimately, it will be necessary to move towards a price-driven, market-based electricity sector, which will in turn make the imposition of a carbon tax easier. Again, there will be transition costs in doing so and these are also potentially capable of coming from the $100 billion.

Bet big on technologies like green hydrogen

A more direct way to de-risk Indian manufacturers from the negative effects of an EU-led CBAM is to move away from dirty fuels like coal to those with lower emissions, like hydrogen. Interesting ideas in this context include the creation of a Green Hydrogen Alliance, which India could champion, much like it did the International Solar Alliance. India could also aggressively court private hydrogen funds such as HY24, established earlier this month with companies such as Air Liquide, TotalEnergies, LOTTE Chemical, AXA, Baker Hughes, and others committing to be anchor investors.

While continuing to push for climate equity more broadly, including at COP26, India will arguably be better served to take these harder steps which will benefit the economy, accelerate our green transition and create greater status for India as a climate leader, while at the same time protecting Indian industry from the negative effects of carbon border taxes.

Akshay Jaitly is President, 262 Advisors; and co-founder of Trilegal.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.