Carbon Border Adjustment Mechanism (CBAM)

Why in News?

As a climate policy tool, CBAM helps reduce global emissions, and also poses significant challenges for developing countries such as India.

What is Carbon Border Adjustment Mechanism (CBAM)?

• CBAM – It is price-based and quantifiable, directly linking market access for carbon-intensive products to carbon emissions.
• Goal – To prevent carbon leakage by imposing a carbon-linked charge on imports based on their embedded emissions.

Carbon leakage – When companies move production of carbon-heavy goods to countries with weaker climate rules to avoid strict emission limits or costly compliance in their home country.

• Proposed In – July 2021 by the European Union (EU) & entered its definitive phase from January 1, 2026.
• Distinction from Traditional NTMs – CBAM is structurally distinct from traditional non-tariff measures (NTMs), such as product standards.
• While NTMs affect market access through compliance requirements and are largely qualitative, with scope for interpretation,
• Impact on Exporters – Even if exporters comply with the product quality standards in destination markets, the carbon intensity of production is likely to raise export costs and thereby constrain market access.
• Additionally, investing in cleaner energy and transitioning toward carbon-neutral production is significantly more expensive than complying with conventional product quality standards, especially in the short run.
• Shift in Global Trade Rules – Market access and export growth are no longer determined by tariffs alone.
• As global trade becomes more tied to carbon rules, a country’s advantage now depends not just on efficiency and price, but also on how carbon-efficient its production processes are.

How the CBAM affected India’s trade?

• Applicability of CBAM – Even as India pursues bilateral trade negotiations with the EU, CBAM will still apply, making carbon-intensive exports to Europe costlier.
• Market Access Beyond Tariffs – Market access, therefore, is increasingly being shaped not only by tariffs but also by compliance with carbon-emission standards.
• Impact on Various Sectors – Its effects may also extend beyond targeted sectors through global price shifts and the gradual adoption of similar policies by other developed countries.
• Immediate Impact – India’s steel and aluminium sectors are likely to face the most immediate impact, given their dependence on European markets and carbon-intensive production processes.
• Although the carbon levy will formally be paid by EU importers, part of the burden is likely to shift to exporters through tighter contracts and stricter supplier selection.
• As European buyers increasingly prefer low-emission suppliers, Indian exporters face a choice to absorb higher costs now or adopt greener production to secure future market access.
• In the short run, compliance costs could shrink profit margins and hurt export competitiveness despite ongoing free trade agreement negotiations.
• Indirect Impact – As a major net importer of fertilizers, India may face indirect price pressures through global price transmission.
• Key fertilizer exporters to the EU — Egypt, Russia, Morocco and China — are also major suppliers of fertilizers to India.
• As these suppliers face higher carbon-compliance costs, part of the burden is likely to be passed on through higher global fertilizer prices.
• India’s fertilizer import bill is therefore likely to increase, jeopardising the agricultural sector, farm profitability and high food prices.
• Structural Shift – CBAM signals a structural shift in global trade, as other developed countries consider adopting similar carbon tariff compliance policies.
• Developing countries like India face constrained market access unless they improve carbon efficiency.

What need to be done to overcome the challenges?

• Domestic Strategy – Countries such as India must adopt a two-pronged strategy of domestic reform and effective international negotiation.
  • Greater investment in clean energy and
  • Stricter implementation of carbon policies are essential to improve firms’ carbon efficiency.
• Domestic Push for Fertilizer – Reducing the import dependence of emission-intensive and more expensive goods such as fertilizers, through
  • Higher domestic production and
  • Better implementation of the soil health cards scheme and
  • The promotion of balanced and need-based application of fertilizers is equally important.
• International Strategy – Internationally, India must negotiate for equitable treatment of developing countries so that the short-run costs of carbon compliance can be eased through a phased transition.
• India must also seek transitional support and technology transfer to ensure a level playing field in trade agreements with developed countries.

What lies ahead?

• The challenge is not merely adapting to carbon-constrained trade regimes, but ensuring that the transition does not undermine growth and sustainability.

Reference

The Hindu | Tariffs to carbon, the new rules shaping India’s trade