Carbon Border Adjustment Mechanism

Context: A concerning development for India is the European Union (EU)’s Carbon Border Adjustment Mechanism (CBAM). The policy, which intends to tax carbon-intensive products coming into the EU from 2026, is divided into two phases, with the first phase (transitional phase) kicking in from October 1, 2023.

What is a carbon border adjustment tax? 

• A carbon border adjustment tax is a duty on imports based on the amount of carbon emissions resulting from the production of the product in question. 
• It is aimed putting a fair price on the carbon emitted during the production of carbon intensive goods that are entering the EU, and to encourage cleaner industrial production in non-EU countries.
• The gradual introduction of the CBAM is aligned with the phase-out of the allocation of free allowances under the EU Emissions Trading System (ETS) to support the decarbonisation of EU industry.

Note: This EU-ETS works for the companies located within the EU borders. CBAM is for those companies which are located outside the E.U.

How the CBAM will work?

• The CBAM puts an emissions tariff on imports of goods with a high risk of carbon leakage from countries which are not members of the EU Emissions Trading System (ETS).
• Companies importing goods into the EU will have to purchase CBAM certificates and then surrender the required amount to cover the corresponding emissions each year.
• There are no limits on the number of CBAM certificates an importer may purchase so as to avoid imposing restrictions on trade.
• Unlike ETS allowances, CBAM certificates are not tradeable nor bankable.

Merits of CBAM (Viewpoint of E.U):

• Preventing Carbon leakage: It refers to a phenomenon where a EU manufacturer moves carbon ­intensive production to countries outside the region with less stringent climate policies and hence it does not reduces the actually carbon emissions, it just shifts the source to other regions. CBAM will try to bring stringency for those industries also.
• Protecting Domestic industries: CBAM will charge the carbon intensive products coming from non-EU countries hence it will ensure level playing field to the domestic companies who by virtue of EU-ETS are already following stringent norms.
• In line with E.U’s green targets: According to the European Commission’s proposal, CBAM would contribute to the achievement of climate neutrality by 2050. This will also help them to reduce GHG emissions by 55% by 2030. It comes under the EU’s Green Deal to.

Issue with CBAM (Viewpoints of India, China & other developing countries):

• Hurting industrial interests: This might hurt Industrial interests in the developing countries as their exports will be charged by EU. For e.g. In FY22, India exported Steel and aluminum related products to E.U to the tune of $10B.
• Violative of CBDR: As CBAM is equally applicable to all the countries outside EU, it violates the principle of ‘Common but differentiated responsibilities’ as was agreed under Paris agreement.
• Green protectionism: This can be misused by EU to unnecessarily levy the import duties on imports. Experts have said that CBAM charge can be around 20-35% but the average levy of EU on the companies within EU is around 2-3%.
• Valuation of carbon embedded: There are huge differences between how the actual carbon content embedded is calculated and valued in other jurisdictions.
• Historical contribution by developing world in climate change is also very low therefore they cannot be charged for their developmental activities.
• FTA agreement and zero duties: It is still not clear that whether CBAM will be applicable in the FTA or not. For e.g If India enters into FTA with EU, then there are chances that EU will impose CBAM making Indian products costly. But India might not reciprocate it leading to zero duties and flooding of Indian markets by EU products.
• Other factors for Industrial location: Just the stringent environmental norms do not govern the shift of industries from EU to Asia & Africa. There are other factors also like cheap labour, availability of land, huge markets, government policies etc. So, the E.U’s argument that Industries shift to other areas just to avoid stringent policies is not completely acceptable.
• Compliance with WTO: Developing countries have also criticised this legislation on account of violative of WTO’s special and differential treatment provisions.

What can be done?

• Funds to developing countries: Experts have suggested that EU could collect the tax and return the funds to such countries to invest in their green technologies.
• Own legislations: India can also come up with their own legislations in this regard.