EU’s Carbon Border Adjustment Mechanism: Why should Indian industry care?
Economic Times, November 10, 2022

By Pradeep S. Mehta, Vinay Piparsania, Julius Waller and Sneha Singh

As we write this, trade and climate change is being discussed at COP27 in Sharm Al Sheikh. The problem in a nutshell is that trade today is associated with an unsustainable level of resource consumption that is contributing to climate change, pollution, and biodiversity loss. It is, therefore, an imperative that we stop ignoring this and viewing trade as a goal in itself and rather, see it as the means for creating more sustainable opportunities of economic growth.

Reflecting a shift in trade ethos, various initiatives are trying to connect sustainable production with sustainable consumption. The European Union’s Carbon Border Adjustment Mechanism (CBAM) is one of them. Having established the Emissions Trading System (ETS) in 2010 that provided carbon emission rights to domestic producers, the EU will now be imposing an equivalent cost on imports to level the playing field between foreign and domestic producers, thereby preventing carbon leakage. From 2026, for the chosen sectors of cement, fertiliser, iron and steel, electricity and aluminium, imports will face an additional tariff in so far as the country of source does not exact an equivalent price for the carbon embedded in them.

This will negatively impact the Indian industry which has significant export interests in the EU. The EU has been the destination for nearly 17 per cent of total Indian exports in the period of 2012-2021.

Around six per cent of these exports will fall under the purview of the CBAM. Of these CBAM-implicated Indian exports, the iron & steel sector, followed by aluminium will be the most affected. Should CBAM expand beyond these five sectors, it will next seek to cover organic chemicals, plastics, polymers and hydrogen. Gradually, almost all carbon intensive sectors will be sought for coverage.

Even as the specific question of CBAM’s legal compatibility with WTO norms remains undetermined, and the general question of the appropriateness of its extraterritoriality acts as a geopolitical thorn, the inevitability of CBAM or CBAM like measures cannot be disregarded. Most countries already have some form of domestic carbon pricing scheme in place. Should CBAM open the pandora’s box of carbon border measures, others, especially the US and Canada may follow suit.

This makes sense in light of highly ambitious carbon neutrality commitments undertaken by over 70 countries, including the biggest emitters – China and the US.

Crucially, over 2,000 companies globally have put in place targets to achieve net zero carbon emissions. These include 35 Indian companies engaged in sectors such as construction, electric utilities, mining, textiles, automobiles and chemicals among others. There is also a general acceptance of Internal Carbon Pricing (ICP) by various Indian businesses, indicating an openness towards adapting to a low carbon future. Thus, even as business and governments, especially from the developing countries register their protest against green protectionism, many of them are simultaneously and pragmatically adapting to the upheaval that greening of supply chains will bring to current levels of competitiveness.

Is the readiness displayed by the Indian industry towards a green transition enough for mitigating the commercial risks emanating from CBAM? Looking at existing surveys, it is safe to surmise that the industry is aware of the initiative but possesses a limited understanding of the same. Further, reliance on governmental opposition of CBAM to buy some respite from adaptation is not a reassuring business strategy.

Rather, the time to act is here and now, especially for the sectors implicated in the immediate future. They must formulate a clear action plan at the sectoral and firm level for mitigating the implementation and compliance costs of CBAM across their supply chains. Further, given that the disruption caused by CBAM will bring in a new paradigm of competitiveness, the industry’s strategy must go beyond preserving the pie that exists and work towards tapping new opportunities for market expansion.

Opportunity in adversity
Pre-emptive adoption of low carbon pathways can catalyse differentiated and resilient growth. Growing public consciousness is leading to a change in consumer preferences that is increasingly creating an incentive to enter a ‘race to the top’ and distinguish products from competitors based on adherence to social values especially climate accountability rather than cost differential alone.

Significantly, even at this nascent stage, there is enough commercial demand to incentivise movement. Public and private steel buyers in downstream sectors are deploying their purchasing power through initiatives such as Steel Zero, Clean Energy Ministerial Industrial Deep Decarbonisation Initiative and the First Movers Coalition. By 2030, McKinsey projects that the demand for green steel in Europe could be double than the available supply. Similar supply shortages are predicted for recycled aluminium.

Beyond product differentiation, surging demand for green goods, services and technologies, especially zero-carbon technologies, give firms opportunities to venture into new business avenues such as electric vehicles, lithium batteries and green hydrogen among others. Top Indian conglomerates have begun this process of diversification.

In conjunction with businesses and consumers, investors too are relying on sustainability linked matrices to enable decision making. The EU and the US are already pushing vigorously for Paris compliant businesses. Several Indian companies are also taking a lead in announcing net-zero targets for raising environmental, social, and governance (ESG)-linked funds. Thus, even though ESG is a relatively new kid on the investment strategy block, India could get a head start in sustainable financing being pro-active. It did so in the case of green bonds, establishing the second largest emerging market globally with $10.3 billion worth of transactions in the first half of 2019.

Seizing the day
However, the charms of ESG finance come with a caveat. As foreign ratings providers tend to compare entities globally, they fail to accommodate the socio-economic realities of emerging economies. This means that Indian firms will have to swiftly catch up with their global competitors.

Moreover, even for the firms that have already commenced the process of decarbonisation, the battle is only half won. Compliance with CBAM requirements will need continued vigilance and monitoring. Not so far into the future, businesses will have to navigate through a blizzard of regulations on sustainability coming their way.

The related issue of coherence comes with an opportunity. Case in point, even though India has not explicitly set a carbon price, several governmental initiatives indirectly tax or put a price on carbon. These include government schemes like Perform, Achieve and Trade (PAT) (rewarding/penalising industrial sectors for achieving/failing to reduce energy consumption per government-mandated targets); Renewable Purchase Obligations (specifying the minimum quantity of electricity to be purchased by distributors from renewable energy sources) and the GST compensation cess on coal.

The PAT scheme is arguably comparable to the EU’s Emissions Trading System (cap-and-trade). There is a potential for finding equivalence between the two or even linking them and creating a larger market for emissions trading through harmonisation of monitoring, reporting and verification (MRV) requirements. Such regulatory coherence could reduce the fears of green protectionism – real as well as perceived and must be studied extensively to arrive at the exact scope of equivalence possible.

Beyond this, the government should also be looking at increasing the capacity of businesses to opt for more sustainable options through domestic incentives as well as trade agreements to thereby shape greener supply chains. Decarbonisation of the value chain will also require lead firms to help shift associated SMEs towards renewable electricity and improve their overall energy efficiency. Notable initiatives in this regard are in progress.

However, the overall policy environment remains disjointed in its application, especially with respect to industries implicated by CBAM.

For instance, even as the National Steel Policy of 2017 aims to significantly increase the production and consumption of steel, it does lip service to the idea of decarbonisation, failing to elaborate how the additional capacity could be rendered sustainable. The Production Linked Incentive scheme on speciality steel similarly remains silent on speciality steel similarly remains silent on this aspect. While various Indian companies have, taken some noteworthy steps, such as the partnership between the Confederation of Indian Industry and Tata Steel to develop GreenPro, the first Indian ecolabelling framework for steel rebars, complementary participation by the public sector will determine the pace at which the Indian industry can adopt lower carbon pathways.

The recent direction by the government asking the steel sector for timebound action for its green transition offers the perfect opportunity for industry to take greater initiative and be more articulate in conveying its actual interest in trade and its associated challenges. At the heart of green transition are exceedingly technical and foundational issues like the standardisation of methods to measure carbon emissions. Greater transparency and regulatory coherence in such standards can accelerate decarbonisation and achieve environmental sustainability without creating unnecessary barriers to trade. Given that the implementation of CBAM is planned to be gradual and incremental, it offers the Indian industry ample openings to place its interests at the negotiating table – should it be primed for action with the right knowledge and intervene at the right time.

In sum, if Indian businesses desire to integrate themselves into global value chains and the future trading order that will be driven by a critical mass of countries riding the green wave, they must pro-actively study and engage in discussions on carbon measures with relevant stakeholders.

Preparing a roadmap for the Indian industry in navigating CBAM and related developments to not just retain but increase their overall export competitiveness will require coordination of efforts from the public and private sector. A dialogue kickstarted by industries implicated by CBAM in conjunction with investors, young entrepreneurs and policy experts can give a much-needed impetus for altering the status quo on discussions of sustainability and responsible business in global value chains.

Indian corporates have great capacity to ratchet measures relating to sustainability and achieve competitiveness that is resilient. The sooner they internalise this, the smoother their future will be.

*Pradeep S Mehta is Secretary General, CUTS International. **Vinay Piparsania is Business Advisor - India at Transnational Strategy Group (TSG), Washington DC. ***Julius Waller is Chairman, European Public Policy Advisers Partnership (EPPA), Brussels. Sneha Singh of CUTS contributed to this article.

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