While the world is grappling with finding finance for energy transition towards low carbon pathway, European Commission has announced a Carbon Border Adjustment Mechanism (CBAM) as a part of its Green Deal (or Fit for package 55).
EU’s CBAM, is an internationally binding unilateral environmental measure with two-fold objectives — one, to achieve 55 per cent net reduction in greenhouse gas emission by 2030; two, to ensure equalization of carbon price between imported goods vis-à-vis domestic goods thereby limiting global carbon leakage and encouraging partner nations to adopt ‘green’ technology.
Despite several internationally coordinated efforts to build resilience against climate change (the Paris Agreement, Glasgow Climate Pact), the EU seems to portray itself as a global ‘boss’ by holding a ‘stick’ (CBAM certificate prices) to achieve the ‘carrot’ — the desirable outcome of other nations to reduce their carbon footprints.
CBAM has been designed initially to cover five industries — iron and steel, aluminum, cement, fertiliser, electricity, and hydrogen generation.
However, EU’s policy document seems to suggest that the mechanism will be expanded to cover 50 per cent of the sectors under the Emission Trading Scheme (ETS). The initial transition phase begins on October 1, 2023, wherein the importers need to declare the emission embedded in their goods, which will be verified by third-party auditing. Accordingly, importers need to purchase CBAM certificates and the price of these certificates will be based on the EU’s existing carbon prices. The exporting countries with stringent emission regulations will be subject to a rebate, equivalent to the difference between their domestic carbon price and the EU’s carbon price under the ETS.
This discriminatory provision across partner countries (discrimination among foreign goods) challenges the Most-Favored- Nations (MFN) principle of WTO, the basic tenet on which the world trade is now governed. The implementation phase of CBAM begins from 2026, accompanied by gradual phasing out of free ETS allowances across the EU’s domestic producers.
Per the press release of European Commission’s dated June 20, 2023, 75 per cent of the estimated CBAM revenue will be allocated to EU budget. Thus, the lofty idea behind CBAM boils down to another tax to fill-up the gap in EU’s budget!
Should India worry?
Per the Ministry of Commerce and Industry data, India’s total export value to the EU stands at $98 billion in FY2022-23. India’s total export of CBAM goods — iron and steel ($5,083.7 million), aluminium ($2,679.7 million), fertiliser ($0.64 million), and cement ($0.04million) account for 8 per cent of India’s total export to the EU in FY2022-23.
Over the last five years, India’s export of CBAM goods to the EU has increased by 84 per cent — from $4.2 billion in 2018-19 to $7.8 billion in 2022-23.
Will the imposition of CBAM impact India’s export significantly? This would of course depend on carbon intensities of India’s CBAM products vis-à-vis her competitors. If India’s carbon footprints on these products are lower than her competitors, it would have no effect on her exports at this point of time.
However, as all nations are attempting to reduce their carbon footprint on all products including CBAM products, in future, the CBAM tax will benefit nations that move faster towards lowering their carbon footprints.
Clearly, to understand the impact of CBAM on India, we need to use a global trade model like GTAP (Global Trade Analysis Project) model with relevant products and competing countries/region built into it.
However, as the standard GTAP database clubs CBAM sectors with others, we created a GTAP database with separate CBAM sectors and our competing nations using supplementary information to understand the impact of CBAM on India’s exports.
According to our modelling results India’s export of fertiliser, cement, and aluminium and iron and steel will decline by 0.07 per cent, 0.62 per cent, 0.004 per cent and 0.06 per cent respectively. The numbers are also small in absolute terms.
Currently, India has vehemently opposed EU’s CBAM. India sees the proposed levy as discriminatory and a trade barrier, and questions its legality. The government has every right to file a complaint to the WTO against the EU’s unilateral decision.
As our findings indicates, the impact on India’s export on these four products will be negligible. However, the danger is that if the EU’s move goes unchallenged, there is every possibility that they will expand the product list in the coming years. At least, their official position seems to suggest so.
While trying to achieve the ‘carrot’, the CBAM can actually induce a distortionary effect in the global trade pattern by altering the global competitiveness of the least developed and developing countries vis-à-vis the developed countries.
Following the commitment of the industrialised countries to reduce GHG emissions under the Kyoto Protocol of 1997, most of the developed countries already have well-defined mechanisms (carbon pricing, emission cap, etc.) to control GHG emissions within their economies. This can give them elbow room to claim a rebate on the price of the CBAM certificates as opposed to the developing or least developed countries without the domestic carbon pricing mechanism.
Moreover, the industrialised nations also enjoy first-mover advantage in the use of less-carbon intensive technologies in their production process. Also export value of CBAM products has declined for developed countries vis-a-vis developing countries.
Apart from the trade-distortion effect, another major concern of the CBAM mechanism relates to financing of the transition towards the adaptation of less carbon-intensive production techniques, especially in the least developed and emerging economies.
Since EU is spearheading the ambitious global climate objectives, it is time to remind EU of its commitment of contributing $100 billion per year to support developing economies to finance their climate action.
Will it not be fair to inject the CBAM revenues back to developing countries? Or, is it a camouflaged trade-barrier, to widen the North-South inequality? As of now, EU has apparently no plan to recycle the CBAM revenue to developing countries.
The writers are with NCAER, New Delhi. Views expressed are personal