India must balance EU carbon tariffs with economic interest, climate action

India’s export-heavy industries are facing a new kind of trade barrier — one centered not on tariffs or quotas but on carbon emissions. The European Union’s Carbon Border Adjustment Mechanism (CBAM), designed to tax imports based on embedded carbon emissions, will fully apply by 2026, with the current transitional phase lasting until 2025.

Currently, EU importers are required only to report the carbon emissions embedded in goods such as iron and steel, cement, aluminium, electricity, fertilisers, and hydrogen from non-EU countries. However, by 2026, these imports will face a carbon levy, with companies needing to purchase CBAM certificates, effectively linking the carbon price to the EU’s Emissions Trading System (ETS). In essence, the EU’s stance is clear: “If our industries pay a carbon price, then imports from countries without similar costs should too.” This is framed as an effort to prevent “carbon leakage” — the concern that, without such a tax, industries might shift production to countries with looser environmental standards, undermining global climate goals. This seemingly technical regulation presents more than just a compliance hurdle for India.

First, the economic implications are likely to be profound. A 2024 Asian Development Bank (ADB) study estimates CBAM could cut India’s gross domestic product (GDP) by 0.12 per cent, with producers facing an implicit tariff of up to 10.5 per cent value-added tax, depending on the carbon intensity of their exports. This burden will be particularly heavy for the steel, aluminium, and cement sectors, which are vital to India’s economy. Iron and steel alone account for 28 per cent of India’s exports to the EU, but these industries rely heavily on coal-based energy, making their products vulnerable to CBAM’s carbon tax. With the EU set to implement full reporting requirements in 2026, some estimates suggest that India’s total exports to the EU could fall by 2.7 per cent by 2030.

Second, sectors like iron and steel could face cost increases of up to $50 per tonne due to the combined impact of carbon taxes and existing domestic levies. The ripple effects could extend beyond reduced export revenues, as higher costs might divert investment to other regions, slowing India’s industrial growth. According to data from the Ministry of Commerce, CBAM-covered goods made up around 9.9 per cent of India’s exports to the EU in 2022-23. The additional tax burden on these exports would be a substantial hit to India’s economy, especially considering the potential for wider implementation across more sectors in the future.

Third, beyond immediate economic costs, there’s a larger, philosophical issue at play — the principle of climate justice, enshrined in international agreements like the Paris Agreement. During COP28, India and other developing nations argued that unilateral measures like CBAM violate the principle of “common but differentiated responsibilities”, which recognises that developed nations bear a greater historical responsibility for global emissions. The EU has outsourced nearly 19 per cent of its emissions through imports from countries like India, while maintaining significantly higher per capita emissions. By imposing a carbon tax on imports without acknowledging this disparity, the CBAM effectively shifts the decarbonisation burden onto developing economies.

So, what can India do about it? One option is to accelerate the development of its own Emissions Trading System. The Bureau of Energy Efficiency has initiated steps to create a domestic carbon market under the Carbon Credit Trading Scheme, but it remains in its early stages. Aligning this system with international carbon pricing mechanisms would allow Indian exporters to demonstrate compliance with global standards, thereby reducing the tax burden under CBAM. In other words, if Indian industries start pricing carbon emissions domestically, they might be able to offset the costs imposed by the EU’s carbon tax, thus maintaining their competitiveness in European markets.

Another option, as rightly suggested by industry leaders like Tata Steel Chief Executive Officer T V Narendran, is for India to introduce its own border tax adjustment mechanism. This would essentially mirror CBAM, but in reverse. Indian industries could impose a carbon tax on imports, levelling the playing field with foreign competitors. It would not only protect Indian producers, but also keep tax revenues within the country. These funds could be reinvested in green technologies, further reducing the carbon intensity of its industries.

India also has a role to play on the global stage, particularly at the upcoming COP29 in Azerbaijan, scheduled for November 11-22. India must advocate for stronger international cooperation on climate-related trade measures. The unilateral imposition of CBAM risks undermining the multilateral trading system, particularly the principles of non-discrimination under the WTO’s Most-Favoured Nation (MFN) rule. India should lead efforts within the WTO to push for a global carbon-pricing mechanism that is transparent, equitable, and universally applied. Such a system would prevent the selective application of carbon taxes and ensure that developing countries are not disproportionately penalised for their carbon-intensive industries.

India must also press developed countries to fulfil their commitments on climate finance and technology transfers. The $100 billion annual climate finance goal outlined in the Paris Agreement remains far from being achieved.

As other major economies like the United States, Canada, and Japan contemplate similar unilateral carbon border measures, it is clear that CBAM-like mechanisms are not isolated; rather they signal a new era of climate-conscious trade policy. As the custodian of global trade rules, the WTO must rise to the occasion and mediate between conflicting national interests.

Diversifying export markets beyond the EU will provide only a temporary solution for India. For policymakers, the way forward will require balancing India’s economic interests with proactive engagement in global climate action. This will be a delicate tightrope walk, testing India's diplomatic acumen, economic resilience, and commitment to sustainable industrial innovation.

The author is Assistant Professor (Economics) at the Indian Institute of Management (IIM) Ranchi. amarendu@iimranchi.ac.in. The views are personal