What is this new legislation about?
In October 2023, the EU starts mandating importing European companies to report and at a later stage (2026) pay for the actual value of embedded emissions of imported goods, especially from high-emitting sectors – calculated based on the weekly average of EU emissions certificates expressed in €/tonne of CO2 emitted –, aiming to protect fair competition and to prevent carbon leakage due to the lack of a global GHG price. If importers can prove that a carbon price has already been paid during the production of the imported goods[1], the corresponding amount can be deducted. This is relevant in the context of existing Energy Savings and Renewable Energy Certificates in India, the Gujarat Air Pollution Cap and Trade Program as well as the announced Indian and other existing and developing (international) carbon credit trading schemes.
In its transitional phase (1 October 2023 – 31 December 2025) the world’s first carbon border tax known as the Carbon Border Adjustment Mechanism (CBAM), will apply to imports of goods listed in Annex I of the Regulation: cement, iron and steel, aluminium, fertilisers, electricity, and hydrogen[2].
Unlike the EU Emission Trading System (ETS) (‘cap and trade system’), CBAM does not impose quantitative restrictions on trade flows. Nevertheless, it has significant implications for (Indo-European) trade and business (relations).
Data Collection & Transparency Requirements
Indian companies already conducting voluntary carbon pricing to encourage the transition to a low-carbon economy are now in a timely advantage to set up monitoring, reporting, and verification (MRV) systems for embedded carbon (reductions) in their products, required by importing companies. Intensified vendor engagement of importers to collect product-level GHG emission data is likely. Installation visits by EU-accredited verifiers are mandatory except where specific criteria for waiving are met (CBAM Annex VI 1(c)). So far, however, CBAM has not received much attention from Asian firm executives.[3]
Costs for fulfilling these transparency requirements will be relatively higher for SMEs, compared to the amount exported. Given that CBAM initially targets a limited set of basic materials, it primarily affects sizable enterprises. However, even firms operating in industries not currently under the purview of CBAM should consider evaluating their prospective exposure to CBAM and commence readiness efforts, as the transition period also intends to scrutinize the inclusion of further goods of energy-intensive sectors covered by the ETS – such as refineries, hydrogen, organic chemicals, and polymers. A timetable will set out their inclusion by 2030.
Supply chain disruptions at the customs border may result from non-declaration by an authorized declarant or incorrect classification.
Competitive Challenges & Chances
The increased cost of a 20-35% tariff and the concurrent subsidy race could result in geographic shifts in supply chains, despite the phasing out of free allocations under the ETS, thus lowering India's exports, production, and GDP.
Regardless of the outcome of the FTA negotiations or likely trade retaliation by India, taking into account Europe's historical carbon emissions, the Task Force on Climate, Development and the International Monetary Fund of Boston University calculates that under the current scope of the Regulation India’s total exports to the EU will fall by 2,7%[4] compared to the baseline without CBAM and the GDP decline by -0.043% in 2030.
Impact on BRICS Exports of CBAM Products to the EU under the current Regulation (% from baseline without CBAM, 2030)
Countries/Region | Chemicals | non-metallic metals | iron and steel | non-ferrous metals |
India | –12.8 | –65.2 | –58.5 | –11.8 |
China | –9.0 | –24.7 | –13.5 | –3.8 |
Brazil | –0.4 | –16.8 | –10.5 | –34.2 |
Russia | –18.3 | –25.9 | –17.3 | 4.4 |
South Africa | –8.7 | –44.3 | –30.5 | –16.0 |
He Xiaobei, Zhai Fan, Ma Jun: The Global Impact of a Carbon Border Adjustment Mechanism, A quantitative assessment, Task Force on Climate, Development and the IMF, March 2022.
However, the Boston Consulting Group suggests that the steel industry of India, due to its high share of minimills helping carbon efficiency, can be competitive with China, Russia, or Ukraine and be in a stronger position to build and obtain partnerships with European customers.
Reflecting the growing significance of sustainable business practices, EU's Carbon Border Adjustment Mechanism ushers in a transformative era for global trade dynamics. While posing challenges for various sectors, it also presents opportunities for low-carbon innovation and competitiveness in India's industrial landscape.
[1] Because “their production has already been subject to the EU ETS through its application to third countries or territories or to a carbon pricing system that is fully linked with the EU ETS”, recital 16 CBAM.
[2] Goods and selected precursors whose production is carbon intensive and at most significant risk of carbon leakage (recital 31 CBAM); calculation methods set out in Annex IV (Art 7 (1)).
[3] The Conference Board: The Impact of Europe's Carbon Border Adjustment Mechanism on Non-EU Businesses, 5 May 2023. https://www.conference-board.org/topics/climate-change/impact-of-carbon-border-adjustment-mechanism-CBAM-on-businesses-outside-EU
[4] The United Nations Conference on Trade and Development (UNCTAD) expects a change of -2.91% in exports of energy intensive products https://unctad.org/system/files/official-document/osginf2021d2_en.pdf p 29.