The EU’s Carbon Border Adjustment Mechanism (CBAM) and the … – The Geopolitics

The European Commission came out with the ‘Fit for 55’ proposal in order to secure the European Green Deal, which seeks to provide a pathway to cut the EU’s carbon emissions by 55 percent by 2030, and achieve a net zero continent wide status by 2050. These measures include the Carbon Border Adjustment Mechanism (CBAM), which seeks to address the imbalances in global efforts to address climate action, and bring them in alignment with the EU’s ambitious goals.

Working of the CBAM

The current global manufacturing and production processes are highly interconnected and interdependent with supply chains spanning across geographies and economies. The climate action policies adopted by different countries show considerable variations depending on considerations such as the political economy, economic and governance structures, socio-cultural factors among others. These variations can lead to a spillover of GHG emissions, via international trade, to other jurisdictions, and lead to ‘carbon leakages’. This can occur if companies based in the EU diversify their production processes to make use of relatively lower emission standards in other countries. Alternatively, intermediate or final use products in the EU market may be replaced through imports which do not conform to these standards.

The CBAM will work as a border tax on such goods or services connected with those jurisdictions, which do not conform to the EU’s climate ambitions. Consequently, importers will have to purchase carbon certificates, which will account for the excess emissions generated during the production process, unless the overseas producer can show that the price has been already paid in a third country. The actual border taxation is scheduled to begin 2026 onwards, with the interim period serving as a transition period, where familiarity with the system can be acquired by all stakeholders. Furthermore, the CBAM will initially apply to select high risk sectors such as iron, steel, cement, fertiliser, aluminium, hydrogen and electricity generation.

Implications for India

The CBAM would have implications on the EU’s trading partners, specially the developing and Least Developed Countries (LDCs). This holds significance for India, given that the EU is one of India’s largest trading partners, its 2nd-largest export market, and that the Indian economy is an import dependent one, having historically been characterised by a current account deficit. As per latest data from the Reserve Bank of India, the current account deficit for the FY 2022-23 stood at 2% of GDP. Given that Indian exports to the 27 member EU were worth $65 billion in FY 2021-22, an increase in prices of these exports on account of the CBAM could exert pressure on these trade volumes and potentially widen the current account deficit.

At the UNFCCC Conference of Parties (CoP 26) held at Glasgow in 2021, India declared its ambition to reach the net zero target by 2070. Some studies have estimated that this would require an economy-wide investment of up to $10 trillion. With the CBAM set to translate into a 20-35 per cent tax on select imports into the EU starting Jan. 1, 2026, this might not befit well for national climate mitigation efforts. As India is the only G20 country on track to meet its Paris Agreement targets, it is imperative that new regional policies do not impede genuine efforts by nations.

Furthermore, certain sectors of the Indian economy such as textiles have seen a decline in its share of global exports, owing to lower costs of production in markets such as Vietnam and Bangladesh. The EU’s apparel imports from Bangladesh, in value terms, were almost five times more as compared to India. Therefore, additional costs due to the CBAM could further reduce the demand as well as the competitiveness of this sector.

The CBAM’s initial application to sectors such as iron and steel could also prove to be a sticking point for India. India is the world’s second largest producer of crude steel, and exports up to 3-5 million tonnes of finished steel to Europe every year. The average carbon emission intensity for Indian steel, being higher than the global average, will entail further technological investments from firms. Given the high capital expenditure needed to achieve this, it raises concerns on loss of market share and lower profits.

Another major challenge lies in the area of effective monitoring, reporting and verification of carbon emission across sectors. The scaling up of this statistical capacity is a work in progress, with additional technological, infrastructural and capacity building support required at all tiers of government. India’s Third Biennial Update Report to the UNFCCC also highlights the challenges to inventorisation on account of a large informal sector, which makes up almost 90% of the workforce.

The CBAM also raises ethical issues with respect to the oft-repeated principle of climate justice, and Common but Differentiated Responsibilities and Respective Capabilities that India and the developing world have been advocating at various forums. As the historical burden of global GHG emissions lies with the developed world, the above principles would mandate that the responsibility of climate action must take the considerations of the developing world into account. Moreover, the developed countries have been unable to meet their financial commitments to jointly mobilize US$100 billion per year by 2020 to address the needs of the developing countries.

Future Prospects

The significance of the CBAM lies in global efforts to limit the average global temperature rise to two degrees Celsius or below above pre-industrial levels, as mandated by the UNFCCC Paris Agreement. The United Nations Environment Programme’s Emissions Gap Report 2022 highlights that the window for action by countries is closing and at current levels of climate commitments, average global temperatures could reach 2.8°C by the end of the century.

However, it is important to realise that the CBAM is one of many policy measures which can be used to improve climate action. A one size fits all approach, albeit gradual in its timeline, could have negative impacts on ongoing trade negotiations (a case in point being the India – EU FTA), and multilateral climate negotiations, which have anyway seen limited success on account of the slow pace of decarbonisation.

The enabling of access to clean technologies and financial support could go a long way in incentivising developing nations to upgrade their climate action targets, for that has been a legacy issue from their standpoint. Furthermore, experts have also suggested sectoral agreements to reduce the emission intensity of key economic sectors, such as steel or aluminum. Other suggestions recommend the redistribution of CBAM generated revenue to the EU’s trade partners to address any negative impacts.

The Think20 engagement group under India’s G20 presidency has also advocated for establishing equivalence between other measures which also seek to limit carbon leakage. The rationale being this is that given the differences in domestic political economies, governance, and regulatory arrangements, alternate policy measures can enable similar GHG mitigation. A case in point is that India has one of the highest effective tax on fossil fuels, at 69%, and could be included in the CBAM tariff calculations.

The move also has geopolitical ramifications, with the BASIC group, comprising India, China, Brazil and South Africa, criticising the CBAM as discriminatory, risking market distortions and aggravating the trust deficit amongst parties. Countries such as Algeria and Equatorial Guinea, which are economically dependent on their mineral trade with the EU, may see a diversification of these exports to regions like the BRICS, SCO, ASEAN, or countries such as China. The consequences of disrupting the minerals supply chain in the European Union would be particularly detrimental considering the substantial trade deficit of large African countries such as Nigeria, which export carbon emission-related products worth over $27 billion to the EU. Such a disruption in the supply chain could have severe implications for the European Union, potentially resulting in geopolitical catastrophes in Europe, and a vacuum in mineral supplies.

Additionally, CBAM like measures should not lead to trade wars, as that will take away from the broader goals of improved climate action. Instead, as they evolve and take shape over the near future, efforts should be made to ensure that they are flexible enough to accommodate genuine concerns from the developing economies, taking domestic and historical factors into account. India, with its G-20 presidency in 2023, possesses the potential to assume a leadership role among the Global South countries, and thereby advocate for a discourse and the re-framework of the proposed CBAM mechanism. Other countries such as the US, UK and Australia have similar schemes in the draft stages, and therefore, India would do well to bring about a consensus among the affected nations, and secure concessions for its economy, specially the MSMEs. By championing the concerns of developing nations and fostering dialogue, India can contribute to shaping a more equitable and sustainable approach to international trade and tariff regulation. 

[Image by catazul from Pixabay]

Pranav Jetley is a Research Coordinator at the Global Counter Terrorism Council (GCTC). His research interests include the field of emerging technologies, and their interface with society, law, governance, and international relations.

Maibam Warish is a Senior Research Coordinator at the Global Counter Terrorism Council (GCTC). His research interests include geopolitical conflicts, political economy, security and strategic studies, India’s Middle East Relations, and Indian Foreign Policy. The views and opinions expressed in this article are those of the authors.