Carbon Border Adjustment Mechanism (CBAM)

  Apr 16, 2023

Q What is the context  ?

A 

• The European Union’s (EU) Carbon Border Adjustment Mechanism (CBAM) has raised concerns in India due to its potential impact on the country’s carbon-intensive exports to the EU. While India has criticized CBAM as protectionist and discriminatory, the debate highlights the delicate relationship between trade and environmental considerations.

Q What is Carbon Border Adjustment Mechanism (CBAM) ?

A 

• CBAM is a key climate law introduced by the European Union (EU). It is designed to address the issue of carbon leakage and create a level playing field for EU industries by imposing carbon-related costs on certain imported products.
• In 2005, the EU implemented the Emissions Trading System (ETS), a market-based mechanism aimed at reducing greenhouse gas (GHG) emissions.
• Under the ETS, industries within the EU are allocated allowances for their GHG emissions, which can be traded among themselves.
• However, the EU is concerned that imported products may not account for embedded emissions due to less stringent environmental policies in exporting countries.
• This disparity could put EU industries at a competitive disadvantage and potentially lead to carbon leakage, where European firms relocate to countries with less strict emission norms.
• To address these concerns, the CBAM imposes carbon-related costs on imports of specific carbon-intensive products. The products currently included are cement, iron and steel, electricity, fertilizers, aluminium, and hydrogen.
• The CBAM requires importers to pay a price linked to the average emissions cost under the EU’s ETS. If the imported products have already paid an explicit carbon price in their country of origin, a reduction can be claimed.

 

Q What are the advantages of CBAM in addressing climate-related challenges ?

A 

• Addressing Carbon Leakage: CBAM helps address the issue of carbon leakage, which occurs when domestic industries relocate to countries with less stringent climate policies, leading to increased global emissions. By imposing carbon-related costs on imported products, CBAM aims to discourage carbon-intensive industries from shifting production to countries with lower environmental standards, thereby reducing carbon leakage.
• Encouraging Global Climate Action: CBAM incentivizes countries with carbon-intensive industries to adopt more stringent climate policies. The mechanism sends a signal that products exported to the EU market should meet similar environmental standards as EU-produced goods. This encourages exporting countries to reduce their greenhouse gas emissions and transition to cleaner production processes, contributing to global climate action.
• Levelling the Playing Field: CBAM aims to create a level playing field for EU industries by ensuring that imported goods face similar carbon costs as domestic products. This helps prevent unfair competition, as it aligns the cost of carbon across different markets. It incentivizes domestic industries to invest in cleaner technologies and processes, knowing that imported goods will also be subject to equivalent carbon-related costs.
• Revenue Generation for Climate Initiatives: CBAM has the potential to generate revenue for the EU, which can be used to fund climate initiatives and support the transition to a low-carbon economy. The funds collected through CBAM can be reinvested in research and development, renewable energy projects, or supporting industries in their decarbonization efforts.
• Aligning Trade and Climate Objectives: CBAM highlights the interlinkage between trade and environmental concerns. It creates an opportunity to align trade policies with climate objectives, fostering greater coherence between economic growth and sustainability. CBAM encourages countries to consider the carbon intensity of their exports and provides an impetus for the adoption of climate-friendly practices in international trade.

 

Q What are the key issues associated with CBAM ?

A 

• Trade Protectionism: CBAM has been accused of being protectionist in nature. Critics argue that it could create barriers to trade and hinder the export capabilities of countries, particularly those with carbon-intensive industries. By imposing carbon-related costs on imports, CBAM may give an advantage to domestic industries and discriminate against foreign competitors.
• Discrimination and Non-Discrimination Principles: CBAM may face challenges in adhering to the principles of non-discrimination within the WTO. While it is designed to be origin-neutral, in practice, it could potentially discriminate between goods from different countries based on varying carbon pricing policies or reporting requirements. This could lead to disputes and challenges under WTO rules.
• Complexity and Implementation Challenges: CBAM implementation involves complex calculations and mechanisms to determine the carbon-related costs of imported products. Setting up effective monitoring, reporting, and verification systems to ensure compliance could be challenging, both for the EU and exporting countries. The administrative burden and costs associated with implementing CBAM may also pose practical difficulties.
• Potential for Double Regulation: Some argue that CBAM may lead to overlapping regulations and duplicate efforts. Exporting countries may already have their own carbon pricing mechanisms or environmental regulations in place. CBAM’s imposition of additional costs on top of these existing measures could be seen as redundant and burdensome.
• Impact on Developing Countries: Developing countries, which often have carbon-intensive industries, may face disproportionate negative effects from CBAM. These countries might struggle to comply with the stringent requirements and costs associated with CBAM, hindering their economic development and ability to compete in global markets.
• Incomplete Accounting of Emissions: CBAM focuses on explicit carbon prices, which may not fully account for the implicit costs associated with products from different countries. This incomplete accounting could result in arbitrary or unjustifiable discrimination and may not effectively incentivize countries to adopt more stringent environmental policies.

 

Q What is WTO Consistency and CBAM potential discrimination ?

A 

• WTO’s non-discrimination principle: The World Trade Organization (WTO) operates on the principle of non-discrimination, treating ‘like’ products from different countries equally.
• Origin-neutral CBAM: While CBAM appears origin-neutral in design, its application could potentially discriminate between goods based on inadequate carbon pricing policies or burdensome reporting requirements for importers. Whether the products affected by CBAM are truly ‘like’ is a key consideration.
• For instance: While steel products may seem similar, different production methods lead to varying carbon intensity. This raises the question of whether processes and production methods should be relevant for comparing products. Critics argue that CBAM violates WTO law by discriminating based on embedded emissions

 

Q What are the General Exceptions under WTO and potential application for CBAM ?

A 

• Exceptions allow countries to deviate from trade rules: The General Exceptions, outlined in Article XX of the General Agreement on Tariffs and Trade (GATT), provide a set of policy grounds under which WTO members can justify trade measures that would otherwise violate their WTO obligations. These exceptions allow countries to deviate from certain trade rules for specified policy reasons.
• Justification for exception: Article XX of the GATT lists various policy justifications, including public health, conservation of natural resources, and protection of the environment. The use of these exceptions is subject to meeting specific requirements, known as the chapeau. The chapeau sets out conditions that must be satisfied to justify a trade measure.
• In the context of the CBAM: A WTO member implementing CBAM measures might seek to invoke the General Exceptions in Article XX of the GATT to justify any potential inconsistency with non-discrimination obligations.
• For example: A country might argue that CBAM measures are necessary for the conservation of exhaustible natural resources or the protection of the environment, thereby justifying any deviation from non-discrimination principles.

 

Q What are the concerns raised in India?

A 

• Impact on Export of Carbon-Intensive Products: India fears that CBAM implementation could severely affect its export of carbon-intensive products, particularly in sectors like aluminium, iron, and steel. These sectors may face significant challenges in accessing the EU market if they are subjected to additional economic costs due to CBAM.
• Protectionism and Discrimination: India has criticized CBAM as being protectionist and discriminatory. It argues that the mechanism may create trade barriers and hinder the export competitiveness of Indian industries. India fears that CBAM could give an unfair advantage to EU domestic industries at the expense of Indian exporters.
• Potential Economic Disruption: The implementation of CBAM may disrupt India’s trade flows and economic stability. The imposition of additional costs on carbon-intensive products exported to the EU market could lead to reduced demand, loss of market share, and potential negative impacts on employment and economic growth in India.
• World Trade Organization (WTO) Challenge: India has contemplated the possibility of challenging CBAM at the WTO’s dispute settlement body. It raises concerns about the compatibility of CBAM with WTO rules, particularly regarding non-discrimination and trade-related principles
• Interplay between Trade and the Environment: The concerns raised by India highlight the broader issue of the interplay between trade and environmental considerations. While acknowledging the need for environmental protection, India emphasizes the importance of ensuring that environmental measures do not become a smokescreen for trade protectionism.

 

Q What can be the way forward ? 

A 

• The implementation of the EU’s CBAM has sparked concerns in India, primarily due to its potential impact on carbon-intensive exports. Analyzing its WTO consistency and potential justifications under the General Exceptions clause is crucial. In the ongoing India-EU free trade agreement negotiations, India should actively engage with the EU to safeguard its interests regarding CBAM while remaining open to the possibility of a WTO challenge.