Slated to become fully operational in 2026, the carbon tax on imports of selected products is supposed to highlight Europe’s ambitious climate action through an import tax that will help it raise €14 billion.

CBAM: Just another brick in the contentious global trade wall?

Europe’s new Carbon Border Adjustment Mechanism has triggered retaliatory announcements from China and India, which may not bode well for crucial trade talks slated for this year

The chaotic start to Europe’s Carbon Border Adjustment Mechanism (CBAM), one of the world’s most controversial mitigation measures, has set off a chain reaction for similar trade protectionist carbon barriers across large economies like the UK, US and China.     

The CBAM, which riled up global trade talks in March, is expected to remain a sore difference when nations meet to discuss global supply chains in May this year. Birthed in 2021 when the century’s worst pandemic, Russia’s attack on Ukraine and the deepening of the US-China economic rivalry, redrew security and trade maps as supply chains were disrupted, Europe’s CBAM was also a recognition that climate change magnified supply risks to the world’s most affluent corners.

Slated to become fully operational in 2026, the carbon tax on imports of selected products is supposed to highlight Europe’s ambitious climate action through an import tax that will help it raise €14 billion, according to the Asian Development Bank.

Yet, the CBAM is expected to cut exports from western and southwestern Asia, including India, to the EU in return for a small reduction in emissions that would quickly be offset by the continuing increase in carbon-intensive production throughout Asia, according to the ADB. Mechanisms to share emission reduction technology would be more effective in place of the unilateral measure, it said. India and South Korea are among Asian nations that will be affected the most even in the initial stages.

About 27% of India’s iron ore pellets, iron, steel, and aluminium exports worth about $8 billion are expected to be hit by the European Union’s CBAM. That may not seem substantial for the world’s fastest growing major economy, considering that overall trade between India and the EU stood at about 30.4 billion Euros in 2020.

For supplier nations like India, the concern, however, is not limited just to the EU’s CBAM measures. The new levy is also being widely watched for its ability to shrink world trade through other similar protectionist measures being announced in the name of climate mitigation. The UK is expected to finalise its version of CBAM this year, while the Republicans and Democrats in the US have introduced four bills on carbon border adjustments. The Global North’s carbon taxes have triggered retaliatory announcements from China and India, threatening the already tenuous export markets for the Global South’s small- and medium-scale enterprises.

Countries should “not be complacent about the CBAM’s limited initial coverage of five sectors,” according to Anuradha R V, partner at New Delhi-based Clarus Law Associates. “The ambit of the border tax is bound to expand to semi-finished and finished products in a review planned next year, given CBAM’s basic objective to level the playing field for EU producers.” That means a wider section of industry, especially India’s MSMEs can expect to be hit.

While the EU’s CBAM will eventually affect the entire production and trade cycle for all products, a similar move is expected in the UK by 2027. In the US, both Republican and Democrat senators are proposing laws to levy environmental charges on imports.

The fear is that this will potentially make UNFCCC climate goals irrelevant, according to Anuradha. Such charges could also cancel out the benefits of tariff reductions and market access India hopes to gain through its ongoing free trade negotiations. Smaller producers remain at risk, as they face not just the financial burden of carbon price differentials, but also significant compliance costs from data collection, auditing, and emissions certification. Understanding this mechanism needs a slight introduction to the concept of carbon pricing.

Measuring the “societal cost” of carbon emissions

CBAM, which has sought to impose tariffs linked to internal EU carbon prices on imports like iron and steel, aluminium, fertiliser and cement, has been designed to mirror the EU’s existing Emissions Trading System (ETS). And is seemingly in line with the widespread acknowledgment that carbon pricing holds the key to mitigating climate change.

A carbon price charges a fee per metric tonne of CO2 emissions to reflect their societal cost. It comes in two forms—a carbon tax and the ETS, known as “cap and trade.” This method motivates companies to lower emissions by adopting greener technologies or methods. Applying carbon pricing broadly across all industries and transport can significantly help in reducing global carbon emissions, according to the World Bank.

In policy terms, the EU has described CBAM as a way to prevent “carbon leakage” where any government attempt to cut emissions by pricing carbon simply leads to emissions-intensive production being moved to other countries.

While the first phase till 2026 covers imports in carbon-intensive sectors, CBAM is expected to apply to a broader range of imports over time. Production in India may face implicit tariffs of about 10.5% value-added tax once CBAM comes into effect fully, according to a study by the Asian Development Bank published in February.

The ETS or calculated price of carbon can directly impact other Asian sub-regions and could account for reductions in GDP in East Asia and Southeast Asia and would have “large negative effects” in India and China, it said.

A heavy price to pay

And while the Indian government has introduced the idea of a new regulation on trading carbon credits, as of today, the country lacks a way to measure the price of carbon embedded in its exports. This knowledge disparity is also a burden, say some.

“The administrative part of it itself will raise costs,” said Ajay Srivastava, founder of the New Delhi-based trade think tank GTRI. “The actual obligation is on the EU importer. But the data they will look for is with the India entity. The costs for satisfying this data requirement will have to be taken into account.”

CBAM also hits at the principle of Common But Differentiated Responsibility (CBDR) enshrined under the UNFCCC climate principles and will impose a heavy cost on developing and underdeveloped nations. The EU nations are among developed nations that agreed to pay their developing counterparts $100 billion in climate finance.

“We sat with the EU at the UN and decided on CBDR and you have an NDC (Nationally Determined Contribution) much higher than mine,” said Srivastava. “So actually, you have to pay me to help me clean up my work. But instead now you are saying to me: pay me if you want to enter my market. You are hitting at my comparative advantage.”

Justice for all?

Yet, approaching the World Trade Organization is not yet an option for nations, including India. While India waits to clear its own carbon credits trading system to counter the EU’s carbon pricing, it has also raised an objection against CBAM at the WTO.

Yet, the WTO’s operational systems, including the dispute settlement body, and the scope of its agendas, which urgently need reforms to address the evolving nature of global trade, remain hobbled by the US. The world’s biggest economy, which also hosts the WTO, has, since 2016, refused to approve new judges to the WTO’s Dispute Settlement Body and has blocked the reappointment of those whose terms have expired.

Yet, as geopolitical tensions like the ongoing Israel-Iran attacks, the Ukraine war and elections across the world raise uncertainties, global trade is expected to run into more protectionist walls. With more extreme weather worsening the climate crisis, nations will have to weigh risks of relying on local markets versus global supply chains.

While affluent nations may find this balance easier for now, it would be crucial for India and other Asian economies to continue building regional and global trade partnerships to boost their economies in the face of future climate risks.

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