Europe's Carbon Border Adjustment Mechanism (CBAM) and Its Impact on Trade and Climate Change

Europe’s carbon burden

The European Union recently announced the gradual implementation of the carbon border adjustment mechanism (CBAM) that is viewed as a resurgence of frictions in an inherently unequal trading system
CBAM is part of EU’s attempts to mitigate the effects of climate change that include an emission trading system used to price emissions

As the EU ramps up its efforts to withdraw free allowances in the system, there is a worry that businesses will relocate to jurisdictions with no such comparable regulations.
Carbon leakage has compelled the EU to supplement its “Fit for 55 Agenda” with a levy on imports from countries that do not price carbon.

The EU is an important trading partner. Even though its regional trade is significant, the composition of trade in specific commodities and services is not EU dominated.
For example, Turkey, Russia, South Korea, India and China are the top five sources of steel imports for the EU. Similarly, Russia and Mozambique account for 50 per cent of its aluminum imports.
Both these products along with cement, fertiliser, electricity and hydrogen will be covered under the initial phase of the CBAM.
The worry is this will significantly impact trade with countries such as India that depend on the EU for its exports 26.4 per cent of India’s exports of products are potentially covered by CBAM.

EU is India’s third largest trading partner, accounting for 10.8% (around €88 billion) of our total trade in goods.
Many within the Indian corporate sector have been preparing for the compliance of CBAM norms.
- For example, Tata Steel operates in the EU market and has experience with transitioning to green steel.
- As per its annual report 2022-23, CBAM will encourage the company to transition faster and the experience will help with the transition in India
Along with it, carbon-related costs (not CBAM) are to be borne by the society, either through higher steel prices or through public spending or subsidies.

It is possible that the EU may end up losing on account of higher input costs as they may be passed on to consumers.
Steel and aluminum are crucial not just for its major exports such as vehicles but also for green transition (aluminum).
CBAM will apply to aluminum even as the EU lists it as a critical mineral and struggles to lift its production.
It is hard to reconcile these with the application of a tariff on imports except for the reason that CBAM is designed to keep countries such as China —suppliers of minerals out of the EU.
A similar approach was adopted in the past to protect smelters.

There is the WTO to contest the measure as discriminatory.
However, CBAM raises more serious concerns on the structure of the manufacturing sector that will be dominated by companies and countries that are able to withstand the winds of change.
The EU and the US have responded to the challenge by designing incentive schemes to attract investments and to remain competitive.
With limited fiscal space, an internal carbon market along with an effective taxing mechanism may not only nudge firms in that direction, but also can support consumers and smaller businesses
Such pricing mechanisms can also work as a tool to negotiate equivalence with the CBAM, as common but differentiated responsibility would mean that India can price carbon differently as per its level of development.

A collection of proposals aimed at updating and enhancing existing EU legislation while introducing new initiatives to align EU policies with the climate objectives agreed upon by the Council and the European Parliament.
It includes a range of measures to reduce greenhouse gas emissions across various sectors.
Objective: To align EU legislation with the EU’s objective of reducing net greenhouse gas emissions by at least 55% by 2030.
This ambitious goal is in line with the Paris Agreement’s long-term target of limiting global temperature rise to well below 2°C above pre-industrial levels.

A proposed policy that would place a price on the carbon content of certain imported goods.
A type of carbon pricing mechanism designed to prevent carbon leakage, which occurs when companies move their operations to countries with weaker climate policies in order to avoid carbon pricing or other climate regulations.
Under it, importers of certain goods into the EU would be required to purchase emissions allowances at the same cost as EU companies under the EU Emissions Trading System (EU ETS).
It ensures an equivalent carbon price for domestic and imported production on selected goods.
- This way, it would also encourage trading partners to reduce their emissions.
Legislated as part of the European Green Deal and takes effect in 2026, with reporting starting in 2023
The European Green Deal is a collection of policy initiatives that were approved in the year 2020 by the European Commission. The overarching goal of these initiatives is to make the European Union climate neutral in the year 2050.

CBAM is significant imitative of EU to check on carbon emission during manufacturing services and trade & commerce which will help in countering climate change
However, there is need that India must respond with a policy that ensures pricing of carbon in line with its development priorities.