TRADE AND CLIMATE SERIES #1

The Global South’s response to a changing

trade regime in the era of climate change
CARBON BORDER
ADJUSTMENT
MECHANISM (CBAM)

Carbon Border Adjustment Mechanism (CBAM) report.indd 1 10/07/24 12:06 PM

 Research direction: Sunita Narain

Writers: Trishant Dev and Avantika Goswami

Editor: Souparno Banerjee

Cover and design: Ajit Bajaj

Graphics: Tarun Sehgal

Production: Rakesh Shrivastava and Gundhar Das

The Centre for Science and Environment is grateful to the Swedish International
Development Cooperation Agency (Sida) for their institutional support

© 2024 Centre for Science and Environment

Maps used in this document are not to scale.

Citation: Trishant Dev and Avantika Goswami 2024. Carbon Border Adjustment Mechanism
(CBAM): The Global South's response to a changing trade regime in the era of climate change,
Centre for Science and Environment, New Delhi

Published by
Centre for Science and Environment
41, Tughlakabad Institutional Area
New Delhi 110 062
Phones: 91-11-40616000
Fax: 91-11-29955879
E-mail: avantika.goswami@cseindia.org
Website: www.cseindia.org

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 TRADE AND CLIMATE SERIES #1

The Global South’s response to a changing

trade regime in the era of climate change
CARBON BORDER
ADJUSTMENT
MECHANISM (CBAM)

Carbon Border Adjustment Mechanism (CBAM) report.indd 3 10/07/24 12:06 PM

 CONTENTS

Introduction P5

Greenhouse gas emissions and trade P8

The Carbon Border Adjustment Mechanism

(CBAM) P12

India and the CBAM P23

China and the CBAM P27

The analysis P29

The way forward P42

Annexure P47

References P50

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 INTRODUCTION
1
The European Union has introduced a carbon border adjustment
mechanism (CBAM) taxing imports like iron, steel, cement, and
aluminium based on the GHG emission intensities
of their production.

The EU aims to protect its firms operating under the Emissions

Trading System (ETS) by imposing similar costs on imports from
countries without a carbon pricing mechanism.

CBAM will hurt the trade competitiveness of developing countries and

place the burden of decarbonisation on them, ignoring developed
nations' disproportionate contribution to the problem, and past
failures to provide green financing and technology.

Developing countries raised concerns at COP 28 in 2023 about the

negative economic impacts of unilateral trade measures like CBAM
on their economies and poverty eradication efforts.

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 INTRODUCTION

T
he world is in a race to build a low-carbon economy. Countries have, in
recent years, proposed or introduced policies and laws to speed up the
transition away from fossil fuels, promote manufacturing of clean energy
technologies at scale, and decarbonise their domestic industry. On the face of it,
this race appears to be a part of the global effort to cut greenhouse gas (GHG)
emissions. But it has sparked fears of economic rivalry and trade protectionism, as
governments — on the pretext of climate action — try to reshore green industries
and dominate the global supply chain of goods and technologies essential to avert
a climate catastrophe.

On December 13, 2022, the European Union (EU) agreed on a preliminary deal for
an EU Carbon Border Adjustment Mechanism (CBAM) or tax on imported goods
such as iron and steel, cement, aluminium, fertilisers, electricity, and hydrogen,
applicable from October 1, 2023. This tax is based on the GHG emissions generated
during the production of these imported goods.

From the EU’s perspective, it is “levelling the playing field” for its own firms —
many of which operate under the EU’s Emissions Trading System (ETS) and pay a
domestic carbon price — cushioning them from competitors who can manufacture
more cheaply in countries with lenient environmental laws. It believes that the
tax would incentivise its trading partners to decarbonise their manufacturing
industry. It also considers the CBAM as a countermeasure to the issue of carbon
leakage, which UNCTAD (UN Trade and Development) defines as “a shift of
polluting industries to jurisdictions with less stringent emission regulations that
might occur with an increase in domestic carbon prices”.1

The consequences for developing countries may be more serious, however,

especially in the short to medium term, with potentially harmful impacts to the
trade competitiveness of their export-oriented industries.

From the perspective of equity and common but differentiated responsibilities

(CBDR), a CBAM is perceived to place the burden of decarbonisation on the
developing world, disregarding the prior failure of wealthy countries to make
good on their promises to ensure that green technologies are more accessible
to developing countries, whether through extending knowledge or providing
financing. According to UNCTAD, “it imposes on developing countries the
environmental standards that developed countries are choosing” 2, and is also seen
as a unilateral trade measure.

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 At negotiations at the UN Conference of Parties (COP) 28 in Dubai in 2023,
developing country Parties and blocs such as the African Group, China, Iran,
Brazil, Egypt, and BASIC raised concerns about such unilateral trade measures
negatively impacting their economies, and hindering their ability to eradicate
poverty and fulfil their commitments to the Paris Agreement. This implies a gradual
convergence of the trade and climate agenda, as climate-related policy tools start
showing the potential to impact global trade balances and competitiveness, and
the subsequent financial health of countries with export-driven economies.

This paper examines the current scope of the EU’s CBAM with a view to
understanding its implications for developing countries, and the role of such
policy tools in the green transition in an unequal and climate-risked world.

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 TPP COMPLIANCE STATUS WITH SOx NORMS

GREENHOUSE GAS
EMISSIONS AND TRADE
2
In the past two decades, the OECD countries’ consumption emissions
have exceeded their production emissions, which means that they
have imported emissions on a net basis.

On average, the EU imported about 19 per cent of its emissions

annually from abroad between 1990 and 2021,

While outsourcing a significant share of its emissions, the EU

continued to occupy carbon space — its 2019 emissions per capita
was 6.5 GtCO2, thrice as high as India, and 43 times
higher than Ethiopia.

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 A
country’s production (or territorial) emissions tell us about the emissions
produced within its domestic territory. Consumption emissions, on the
other hand, indicate emissions from the production of all imported goods
and exclude emissions from goods exported to other countries. In other words,
consumption-based emissions “reflect the consumption and lifestyle choices of a
country’s citizens”.3

In the past two decades, OECD countries’ consumption emissions have exceeded
their production emissions, which means that they have imported emissions on
a net basis. For some countries, this is larger — on an average, the EU imported
about 19 per cent of its emissions annually from abroad between 1990 and 2021,
hitting a peak of 26 per cent in 2008. The US, on an average, imported about 5 per
cent of its emission during the same period.

Table 1 shows the net emissions transfer — production emissions minus

consumption emissions — as a percentage of production emissions to estimate
how much of a countries’ emissions have been imported or exported. Countries
like India and China produce goods that then get exported and used abroad: on an
average, India exported 6 per cent of its emissions and China 12 per cent, annually
between 1990 and 2021.

The rates of emission transfer have varied, depending on multiple economic factors
both domestic and international, particularly for China — which saw its highest
share of emissions exported abroad till the mid-2000s, followed by a decline after
the financial crisis of 2007-08 (see Graph 1).

Table 1: Emissions transfer as percentage of production emissions (1990-2021)

EU-27 has been a net importer of emissions
Region Average
India 6%
China 12%
Non-OECD 9%
EU-27 -19%
USA -5%
OECD -11%
Source: CSE, Global Carbon Project

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 GREENHOUSE GAS EMISSIONS AND TRADE

Graph 1: Emission transfers (production minus consumption emissions), 1990-2021

Rate of transfers have varied, depending on economic factors

500

400

300

200

100

0
2002

2020
2014
1990

2005
2000

2011

2016
2017
1998

2019
1993
1994

2008
2003

2012

2021
2004
1991

2015
1996
1997

1999

2001

2010
2006
2007

2009
1992

2013

2018
1995

-100

-200

-300

India China EU27 USA

Source: CSE, Global Carbon Project

For the EU, which is the focus of this paper, household final consumption
expenditure of goods rose from around €2,497.8 billion in 2004 to €3,997
billion in 2022 (at current prices).4 During the same period, the import
of goods into EU (excluding intra-EU trade) increased from €915 billion
to €3,006 billion, representing more than a threefold rise (see Graph 2).5
In 2004, the value of imported goods accounted for 36.6 per cent of the household
final consumption expenditure of goods in the EU. By 2021 and 2022, this figure
had risen to 56.6 per cent and 75.3 per cent, respectively.

A large proportion of the increase in imports is in the high-emitting sectors (see

Graph 3).

Between 2009 and 2022, import penetration — percentage of domestic demand

met by imports — of steel in the EU increased from 16.3 per cent to 23 per cent.

In 1995, the net imports of aluminium in EU countries accounted for 36.9 per
cent of the total aluminium used in the bloc; by 2021, this figure had risen to 54
per cent.6

While outsourcing a significant share of its emissions, the EU continued to occupy

carbon space — its 2019 emissions per capita was 6.5 GtCO2, thrice as high as
India, and 43 times higher than Ethiopia.

10

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 Graph 2: EU’s consumption expenditure of goods vs import of goods (in billion Euros)
Value of imports as a percentage of household final consumption expenditure rose more than threefold in two decades

4500
Consumption Expenditure of Goods Vs. Import of Goods

4000

3500

3000
(In billion Euros)

2500

2000

1500

1000

500

0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Extra-EU import of goods Final consumption expenditure of goods

Note: Extra-EU refers to the EU’s trade with other countries, while intra-EU is trade within the bloc
Source: Eurostat, OECD

Graph 3: Increase in extra-EU imports of high-emitting sectors (2002-2022)

High-emitting sectors account for a large proportion of the rise in imports

900
Mineral fuels, lubricants and related materials
800 Machinery and transport equipment
Other manufactured goods
700
Chemicals and related products, n.e.s.
600 Food, drinks and tobacco
In billion Euros

500 Raw materials

400

300

200

100

0
2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

Note: excluding not classified

Source: Eurostat

11

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 TPP COMPLIANCE STATUS WITH SOx NORMS

THE CARBON
BORDER ADJUSTMENT
3
MECHANISM (CBAM)
The CBAM imposes a tax on imports based on emissions generated
during production. Importers will be required to purchase CBAM
certificates and surrender them annually.

By 2028, CBAM is expected to generate approximately €1.5 billion

per year, with 75 per cent of the revenue allocated to the EU budget
and 25 per cent to national budgets.

Importers must register with authorities and purchase CBAM

certificates, with the price tied to the weekly average auction price
of EU ETS allowances. They will declare the emissions of imported
products at the end of the year and surrender equivalent certificates.

Several studies have assessed CBAM's impact on global trade.

Countries with high export dependence on the EU and carbon-
intensive production are expected to be significantly affected.

12

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 C
urrently being implemented, the Carbon Border Adjustment Mechanism
(CBAM) is a border carbon adjustment (see Box) measure proposed by the
European Union. It was introduced as part of the EU’s ‘Fit for 55’ package,
which aims to reduce GHG emissions of the bloc by at least 55 per cent by 2030.
Adopted in May 2023, CBAM aims to ensure that European companies, which
are required to pay for their CO2 emissions, compete on equal terms with non-EU
companies importing products to the EU.

EU’s justification for a CBAM

The European carbon pricing system, implemented through the EU ETS (see
Box), does not currently impose a uniform carbon cost across all sectors. While
the power sector largely pays for allowances known as EU Allowances or EUAs
(recently priced between €80 and €1007), the industrial and aviation sectors
predominantly receive free EUAs. The primary justification for free allowances
is the potential for carbon leakage — if industries are required to pay a carbon
price, they may shift production to jurisdictions outside the EU that do not have
a carbon price.

The EU’s CBAM imposes a tax on imports based on two factors:

• emissions associated with the production of a given imported good, such as an
iron bar
• carbon price borne by EU companies

WHAT IS A BORDER CARBON ADJUSTMENT (BCA)?

A border carbon adjustment (BCA) is a tax on imported goods based on the emissions generated
during their production; it aims to establish a fair playing field by pricing the carbon emissions
of imported products when a comparable pricing mechanism is already in place in the domestic
market. The goal is to prevent any disadvantage for domestic producers in comparison to their
imported counterparts.

BCA can be considered as a form of a trade remedy, similar to anti-dumping or countervailing

duties. It can be implemented to counteract potential distortions in trade caused by differences in
environmental regulations and carbon pricing between trading partners.

BCAs are a carbon pricing tool. Carbon pricing mechanisms are designed to reduce greenhouse
gas (GHG) emissions by assigning a monetary value to units of greenhouse gases and penalising
emissions accordingly. This is typically done either through carbon markets or carbon taxes. While
emissions trading systems (ETS) are an example of carbon pricing through carbon markets, such
as the EU ETS, BCAs are an example of carbon taxes, such as the European Union’s Carbon Border
Adjustment Mechanism (CBAM).

13

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 THE CARBON BORDER ADJUSTMENT MECHANISM (CBAM)

THE EU’S ETS

The European Union’s (EU) emission trading system is a regulated carbon market introduced by
the EU in 2005. Under this, the EU government sets an annual cap on the total GHG emissions
that a sector can emit. Sectors covered include electricity and heat generation, aviation, and heavy
industries. The cap, set annually, is decreased by a certain percentage each year. The cap set for
2024 is 1.38 billion tonne of CO2e for all installations.8

This cap means that the EU will issue an equivalent number of permits known as EU Allowances
(EUAs) to industries covered by the regulation. These EUAs are either auctioned through the
European Energy Exchange or, in certain sectors, distributed for free.

At the end of each year, industries are obliged to surrender EUAs equivalent to the amount of their
own emissions back to the European Commission. For instance, if an entity emitted one million
tonne of CO2, it would have to surrender one million EUAs to the commission.

EUAs are also tradable between entities in the secondary market. For example, if an entity has 0.8
million allowances but has emitted 1.2 million tonne of CO2, it needs to surrender 1.2 million EUAs
and must buy an additional 0.4 million allowances. These allowances can be obtained from other
industries with surplus EUAs.

Figure: EU’s Emissions Trading System (ETS)

ETS allows governments to put a cap on total annual GHG emissions from a sector

buys allowance certificate

surrender allowance
certificate

1
At the beginning
of each year, entity
anticipates its emissions
and buys equivalent number
of allowance certificates
Over-Achieved Limit
Exceeding Limit

from authorities
3 2 4
At the end of the year,
entities surrender
allowances
equivalent to their
actual emissions
Falls short of allowances to Has extra allowances,
surrender, so needs to buy decides to sell it in
allowance from the market the market

Source: CSE

14

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 Importers would be required to purchase ‘CBAM certificates’ and surrender them
annually based on the emissions of goods imported. The mechanism initially covers
select goods such as iron and steel, cement, fertilizers, aluminium, electricity and
hydrogen.

One way to view the problems in this kind of a set-up is to look at the emission
reduction over the years from the system (see Graph 4). Even though emissions in
the power sector in EU have decreased over the years, there has been no significant
impact on industries or the aviation sector. Emissions decreased in the industrial
sector by a meagre 1.3 per cent between 2013 and 2019; in aviation, emissions
actually increased. There is no incentive to decarbonise, as large amounts of free
units — as much as 95 per cent of the total allowances — are available, virtually
eliminating carbon pricing for them.9

Graph 4: Emissions: The rise and the dip

Emissions in the industrial sector (recipient of free allowances) did not decrease as much as in the
power sector (which pays for allowances)

Source: LIFE ETX (2024)

15

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 THE CARBON BORDER ADJUSTMENT MECHANISM (CBAM)

DID THE EU ETS REDUCE EMISSIONS?

Studies estimate that the ETS has played a varying role in reducing emissions in the EU. A study
by OECD (Organization for Economic Cooperation and Development) and the London School of
Economics found that the ETS led to a 10 per cent reduction in carbon emissions between 2005
and 2012, in four countries studied.10 Another study by the University of Oslo in Norway finds
that ETS reduced the EU’s total emissions by 3.8 per cent, but admits that some of the emissions
may have been relocated to other countries through carbon leakage, an aspect the study did not
quantify.11 Others have stated that it is unclear to what extent the ETS has reduced emissions.

Power sector emissions have declined 27 per cent in the EU between 2005 and 2016, but this is
driven by multiple factors beyond the ETS, including renewable energy deployment, a decrease
in total power generation, and switching from coal to gas, according to a report by the European
Roundtable on Climate Change and Sustainable Transition (ERCST).12 The ETS did catalyse the
transition towards renewables, but was not the main driver.

In terms of policies, a 2024 report by LIFE ETX Project (funded by the European Union’s LIFE
Programme) states that “other key drivers of the decarbonisation of the EU power sector include
the Energy Efficiency Directive, which has helped tame the demand for energy, the Industrial
Emission Directive, which has helped limit non-CO2 air pollutants, and national plans for phasing
out coal and lignite in the power mix”.13

To transition away from free allowances for industries within the EU ETS and incentivise these
industries to accelerate their decarbonisation efforts, it is argued that a border tax is necessary.
This tax would essentially apply a carbon price to products imported into the EU. Such a measure
aims to ensure that EU industries are not disadvantaged by having to pay a carbon price while
importers do not, thereby discouraging carbon leakage.

It is a strategic measure to safeguard the competitiveness of EU industries within the EU.14

The gradual phase-in of CBAM will, therefore, be accompanied by a gradual phase-out of free
allocations over nine years between 2026 and 2034.

Figure: Domestic industry in EU hopes that CBAM will level the playing field

EU Company If I need to buy permits for my

emissions, they should too!

Importer
Importer buys CBAM certificates at the start of the year.

Surrenders certificate equivalent to import embedded emissions at the end of the year.

16

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 Policymakers worry that implementing an effective carbon price on industrial
emissions would lead to carbon leakage; companies might relocate production
to regions with lower environmental standards to evade carbon pricing or lose
market share to producers from outside the EU due to competitive disadvantages.

Revenues from the CBAM

As of 2028, the EU CBAM is expected to generate about €1.5 billion per year.15
Seventy-five per cent of this revenue would go to the EU budget, and 25 per cent
would go to the EU countries’ national budgets (see Graph 5).

Despite earlier discussions on exempting the least developed countries (LDCs)

from the mechanism, no such provisions has been envisaged in the regulation.
Furthermore, no provision for the sharing of CBAM revenues with LDCs has been
agreed upon, despite initial discussions and demands for the same. Suggestions
to direct CBAM revenues towards the Loss and Damage Fund, or towards
decarbonisation in developing countries, have also not made it into formal EU
policy.

Graph 5: CBAM-covered emissions and projected revenues

CBAM is expected to generate over 1 billion Euro by 2028

Source: S&P Global

17

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 THE CARBON BORDER ADJUSTMENT MECHANISM (CBAM)

Figure: Timeline of CBAM roll-out

Oct 1, 2023 Jan 1, 2026 Jan 1, 2030

Transitional Period Fully Operational Expansion

Report at the end of each quarter, Importers will start surrendering CBAM Other sectors covered in EU ETS
the embedded emissions in certificates annually. Certificates priced to be included under CBAM E.g.-
imported goods quarterly on weekly EUA values ceramics, paper, etc.
Source: CSE

Table 2: CBAM timelines and requirements

Timeline Activity
October 2023 Quarterly report from importers on goods imported, production methods and emissions
Until July 2024 For emission factor, default values (tonne CO2e/tonne goods) for different products, published by EU
could be used. This is not country specific.
Using default emission factor implies that in the absence of a measured emission factor, industrial
facilities can use default emission factors to report emissions.

Total emissions = weight of the imported good x emission factor (default value)

Source: European Commission

Until December 2024 Another option to calculate emissions can be any of the following three options:
• A carbon pricing scheme in the exporter country
• A compulsory emission monitoring scheme where the installation is located
• Emission monitoring by the producer which is verified by a third party accredited verifier
Beyond December Calculations of emissions could be based on the following two options:
2024 Option 1: Measure emissions from source streams using activity data from measurement systems and
calculation factors from laboratory analyses or standard values. For instance, in steel manufacturing,
measuring emissions from source streams using activity data involves:
• Collecting data on the materials used, such as iron ore and coal, and the processes involved in
steelmaking.
• Installing measurement systems at various points in the manufacturing process to track factors like
energy consumption, raw material usage, and emissions.
• Using laboratory analyses or established standard values to calculate the emissions produced based
on the activity data collected. This includes factors like the carbon content of fuels burnt during
production and the efficiency of the steelmaking process.
• Applying the collected data and calculation factors to determine the amount of GHG emissions
associated with the production of steel in the installation.

Option 2: Measuring emissions from emission sources through continuous monitoring of greenhouse gas
concentration in flue gas and flue gas flow.
(See annexure for snapshot of methodologies)
From 2026 Actual purchase of certificates to cover emissions from imports.

18

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 How will the CBAM be measured and reported?
According to the EU, methodology for implementing the CBAM would be as
follows16:
• Importers will register with authorities and buy CBAM certificates. The
price will depend on the weekly average auction price of EU ETS allowances
(€/tCO2).
• At the end of the year, the importer will declare the emissions of products
imported and surrender an equivalent number of certificates to the authorities.
• If a carbon price has already been paid in the exporting territory, an equivalent
amount will be deducted from what the EU importer is liable for.

Impacts of CBAM on trade

Several recent studies have assessed the impacts of CBAM on trade between the
EU and the rest of the world.

The World Bank has developed a CBAM Exposure Index for countries. It measures
the absolute cost impact on countries from buying certificates, the number of
which depends on their exports to the EU and the respective carbon intensities of
the products exported.

This index scores countries based on the excess cost of CBAM certificates paid by an
exporter over the cost paid by an average EU producer for the same output, reflecting
the effect on competitiveness in the EU market (relative carbon price borne). This is
adjusted by the respective country’s proportion of exports to the EU market (reflecting
the exposure of the exporter country). This adjustment means that a higher reliance
on the EU market for a country means it is more exposed to the EU.

Mathematically
Relative CBAM exposure = (emission intensity of exported product - emission
intensity of EU product) x exports to EU (% of country’s total export to the world)
x carbon price at $100/tonne CO2e

Map 1 considers the iron and steel sector to show the relative CBAM exposure
of countries. Red indicates a decrease in relative competitiveness for countries,
whereas green indicates a gain in relative competitiveness for countries compared
to the EU.

For all the CBAM sectors taken together, the index developed is ‘aggregate relative
exposure’. Thus, countries that have high export dependence on the EU and have
the most carbon-intensive production chains, are hit the hardest by CBAM.

19

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 THE CARBON BORDER ADJUSTMENT MECHANISM (CBAM)

Map 1: Relative CBAM exposure of iron and steel exports to the EU from
various countries
Zimbabwe, India and Ukraine register high relative CBAM exposure in the iron and steel sector

Source: World Bank

The African Climate Foundation and the London School of Economics have
studied the impacts of CBAM on African countries.17 The analysis utilises
computer modelling to explore various scenarios and outcomes. Initially focusing
on a specific set of goods, the report indicates a limited impact on African exports,
as these goods represent only a small portion of the continent’s total exports.

However, upon expanding the scope of the mechanism to include all goods, the
report identifies damaging effects on African economies. Under partial coverage of
products with a simultaneous phasing out of free allowances in ETS for the same,
the analysis predicts a 0.33 per cent decline in Africa’s GDP. It includes India in
its analysis and finds a 0.12 per cent decline in India’s GDP if the carbon price is
assumed to be €40.

A 2024 study by the Asian Development Bank (ADB) finds that CBAM is anticipated
to significantly disrupt global trade, resulting in a 1.1 per cent reduction in Asia’s
exports to the EU.18

20

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 Graph 6: Aggregate relative exposure of taxed product exports from various
countries and relative GDP value of exports
Aggregate relative exposure for developing countries is significantly higher in general than for
developed countries
Product exports to Product exports Aggregate relative
the EU (% of product to the EU CBAM exposure
exports to world) (% of GDP) index
Zimbabwe 86.96 0.43 0.087
Ukraine 37.11 2.36 0.052
Georgia 34.80 0.29 0.046
Mozambique 73.73 6.92 0.045
India 18.92 0.10 0.030
Belarus 50.17 1.36 0.030
Trinidad and Tobago 11.51 0.96 0.029
Egypt, Arab Rep. 37.85 0.35 0.022
Russian Federation 31.43 0.66 0.019
Kazakhstan 13.74 0.18 0.015
Venezuela 44.53 0.17 0.014
Cameroon 93.38 0.21 0.012
Tajikistan 17.74 0.08 0.009
South Africa 16.52 0.20 0.008
Turkey 43.45 0.81 0.004
Iran, Islamic Rep. 5.23 0.04 0.004
Tunisia 43.33 0.47 0.004
Vietnam 5.53 0.11 0.004
Azerbaijan 15.91 0.09 0.004
Bahrain 14.13 1.17 0.003
Hong Kong, China 4.86 0.01 0.003
China 8.60 0.05 0.002
Brazil 11.46 0.05 0.002
Oman 2.76 0.11 0.002
Saudi Arabia 2.42 0.02 0.002
Indonesia 6.22 0.04 0.002
United Arab Emirates 14.49 0.35 0.002
Pakistan 1.23 0.00 0.002
Argentina 2.17 0.01 0.001
Peru 1.10 0.00 0.001
Malaysia 5.53 0.11 0.001
Kuwait 3.30 0.00 0.001
New Zealand 4.52 0.02 0.000
Mexico 1.86 0.01 0.000
Thailand 3.93 0.03 0.000
United States 9.73 0.01 0.000
Canada 2.60 0.02 0.000
Korea, Rep. 10.05 0.18 0.000
Singapore 1.04 0.00 0.000
Philippines 1.56 0.00 0.000
Costa Rica 0.95 0.00 0.000
Australia 1.40 0.00 0.000
Source: World Bank

21

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 THE CARBON BORDER ADJUSTMENT MECHANISM (CBAM)

Graph 7: Potential changes in CO2 emissions (million metric tonne of CO2) of different regions
under different ETS and CBAM policy scenarios
The effect on global emissions is perceived to be marginal

Source: ADB

Will CBAM reduce global emissions?

The ADB suggests that implementing both the ETS and CBAM with a €100
per metric tonne carbon price would decrease global emissions by 1.26 per cent.
However, implementing the ETS alone would lead to a decrease of about 1.08
per cent. Therefore, the CBAM, in addition to the ETS, appears to affect global
emissions only marginally, projecting an additional decrease of approximately 0.2
per cent.19

Similar results have been found by the African Climate Foundation and the London
School of Economics — under full coverage of products and a carbon price of €87,
CBAM could lead to only a 0.04 per cent fall in global CO2 emissions.20

In 2009, a study by the Brookings Institution and Syracuse University (both US-
based) observed that any emission reduction would primarily stem from decreased
international trade, which dampens global GDP and consequently, emissions.21

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 INDIA AND THE CBAM
4
India’s CBAM-covered goods’ exports to the EU comprised 9.91 per
cent of its total goods exports to the EU in the year 2022-23.

CBAM would impose a tax burden of 25 per cent on average, over

and above the value of CBAM-covered goods exported to the
EU from India.

For 2022-23, this tax burden would be equivalent to 0.05 per cent
of India’s GDP.

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 INDIA AND CBAM

A product-wise analysis of CBAM-covered sectors and their corresponding exports

from India shows that the country’s CBAM-covered goods’ exports to the EU
comprised 9.91 per cent of its total goods exports to the EU in the year 2022-23.

By value, this was about 0.2 per cent of India’s GDP in 2022-23.

These exports comprise about one-fourth (25.7 per cent) of India’s total goods
exports to the world for the CBAM-covered sectors, which is not insignificant for
the industries operating in these sectors. These are iron and steel, aluminium,
fertilizers and cement. Currently, hydrogen and electricity are not exported from
India to the EU.

Of India’s total goods exported to the world, CBAM-covered goods exports to the
EU comprise only about 1.64 per cent.

Of India’s total exports of all goods, exports from the sectors subject to the EU
CBAM account for 6.38 per cent.

Comparing trade data of three years to capture fluctuations in trade volumes, our
estimates suggest that at a rate of 100 Euro (or US $106) per tonne of carbon
dioxide equivalent, a CBAM would impose a tax burden of 25 per cent on
average, over and above the value of CBAM-covered goods exported to the
EU. Taking 2022-23 as a sample year, the tax burden would be equivalent to 0.05
per cent of India’s GDP.

Figure 2: Percentage share of India’s exports (2022-23), expressed in $ value of

exports (2022-23)
Of India’s total exports to the EU, CBAM-covered exports accounted for a little over 9 per cent

Worldwide exports of all goods from India

16.59% of

6.38% of

1.64% of

Worldwide exports
Total goods CBAM-covered goods of goods from
exports to 9.9% of exports to the EU 25.7% of sectors covered
the EU under EU CBAM

Source: CSE, based on data from the Ministry of Commerce, Government of India and the European Commission

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 Table 3: Sectoral breakdown: India’s exports in CBAM-covered
sectors (2022-23)
Goods covered by CBAM accounted for 9.9 per cent of India’s total goods exports to the EU
Total worldwide exports Exports to EU 2022-23 EU exports as share of
CBAM-covered sector
2022-23 (M $) (M $) worldwide exports 2022-23
1. Aluminium 8,682 2,234 26%
2. Cement 3 0 1%
3. Electricity 1,181 0 0%
4. Fertilizers 101 1 1%
5. Iron and steel 18,833 5,179 28%
6. Hydrogen 0 0 -
Total of CBAM-covered
28,800 7,414 26%
sectors (1 to 6)
Source: CSE, based on data from the Ministry of Commerce, Government of India

Table 4: Emissions from CBAM-covered sectors and estimates of the resultant tax burden
CBAM would impose an average tax burden of 25 per cent on the value of CBAM-covered goods exported to the EU
from India
Item Sector 2021-22 2022-23 2023-24
Aluminium 685,237 741,423 372,320
CBAM-covered goods traded by weight (in tonne)* Fertilizers 213 315 499
Iron and steel 5,131,790 3,732,842 4,701,786
A. Total weight of CBAM-covered goods traded (In tonnes) 5,817,239 4,474,580 5,074,605
Aluminium 2,257 2,234 1,046
Value of CBAM-covered goods (In M $) Fertilizers 0 1 2
Iron and steel 7,026 5,179 5,321
B. Total value of CBAM-covered goods exported (M $) $ 9,283 $ 7,414 $ 6,368
C. Total value of CBAM-covered goods exported minus value of 13
$ 9,167 $ 7,297 $ 6,250
iron and steel products with no data available in weight (M $)
Aluminium 7,255,611 7,828,244 3,940,043
Emissions of CBAM-covered goods (in tonne of CO2 equivalent)** Fertilizers 335 547 939
Iron and steel 12,988,685 9,596,989 12,072,123
D. Total emission of CBAM-covered goods exports (tCO2e) 20,244,631 17,425,781 16,013,105
E. CBAM cost at Euro 100 / tonne (in million Euros) € 2,024 € 1,743 € 1,601
F. CBAM cost (In million dollars; where 1 Euro = $1.06) $ 2,146 $ 1,847 $ 1,697
Additonal tax burden: CBAM as % of total value of CBAM-
23% 25% 27%
covered goods exported (F as % of C)

*Other sectors (Cement, hydrogen, electricity) have been removed due to their small or nonexistent export values.
**Default value of product-wise emissions intensity provided by the EU
Source: CSE, based on data from the Ministry of Commerce, Government of India and the European Commission

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 INDIA AND CBAM

Graph 8: European Union’s trade with India (2022)

Primary goods and industrial raw materials made up 46.6 per cent of the EU’s imports from India; semi-
manufactured goods and machinery constituted 60 per cent of its exports to India

Import from India (M€) Export to India (M€)

Agricultural products (food,
including fish, and raw materials)
4,776 2,370

Fuels and mining products 8,773 3,613

Iron and steel 5,709 1,097

Chemicals 12,228 7,739

Other semi-manufactures 8,559 7,413

Machinery and transport 14,404 20,622
equipment

Textiles 2,979 245

Clothing 5,034 161

Other manufactures 4,920 3,628

Other products 77 254

Other 128 408

Source: Director General of Trade, European Commission

Measures to counter a CBAM include having a domestic carbon price through a

domestic carbon market. While a new domestic compliance carbon market is under
development, in India — the Carbon Credit Trading Scheme (CCTS) spearheaded
by the Bureau of Energy Efficiency — it is unclear when the market will be ready to
offer an equivalent carbon price to that of the EU to counter the CBAM exposure.

Moreover, as discussed in later sections, a number of other initiatives aiding

decarbonisation in India such as a non-fossil power target in its NDCs (Nationally
Determined Contributions) may not be considered by the EU since the CBAM is
hinged on carbon pricing as a matrix to determine the extent to which goods from
the exporting country should be taxed.

As an interim outcome, the rollout of the CBAM is likely to spur efforts to develop
robust carbon accounting methods and protocols for domestic industry to
commence the emissions monitoring and reporting phase.

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 CHINA AND THE CBAM
5
In its current form, CBAM is expected to have little impact on China’s
trade with the EU, as CBAM-covered exports comprise under 2 per
cent by value of the total exports from China to the EU.

China has implemented a national ETS since 2021. While the carbon
price in the China ETS remains around US $10 per tonne, the carbon
price in the EU is almost 7 to 11 times higher.

China’s exposure to the CBAM would increase significantly once the

scope of CBAM is expanded to include other sectors.

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 CHINA AND CBAM

I
n its current form, CBAM is expected to have little impact on China’s trade
with the EU, as CBAM-covered exports comprise under 2 per cent by value of
the total exports from China to the EU22, compared to 9.9 per cent for India.

China has implemented a national ETS since 2021, which presently covers only
the power sector, with plans for future expansion. While the carbon price in the
China ETS remains around US $10 per tonne, the carbon price in the EU is almost
7 to 11 times higher, ranging between US $60 and US $110 per tonne of CO2e over
the last two and a half years (November 2021-May 2024). Additionally, China’s
ETS currently does not set a ceiling on emissions. With limited coverage, free
allowances, low prices, and data integrity issues, China’s ETS falls far behind the
EU ETS. CBAM may help mature China’s carbon measurement and accounting
system by strengthening its own ETS.

But China has criticised the mechanism at several fora, including the World
Trade Organization (WTO), as a unilateral measure and a trade barrier. For one, a
unilateral measure means the EU has complete authority over the policy and can
leverage it to its interests. Secondly, with the expansion of CBAM, when it comes
to include more products, China’s exposure to CBAM increases by a huge margin.
Thirdly, similar measures from other countries including the US, UK, Canada and
Japan may amplify the exposure of Chinese exports to border adjustment taxes.

Graph 9: European Union’s Trade with China (2022)

Primary goods and industrial raw materials make up a small percentage of China’s export to the EU

Import from China (M€) Export to China (M€)

Agricultural products (food,
including fish, and raw materials) 11,454 20,959
Fuels and mining products 10,030 7,607
Iron and steel 7,411 2,414
Chemicals 66,444 37,922
Other semi-manufactures 46,554 9,338
Machinery and transport 3,34,451 1,20,096
equipment
Textiles 13,508 1,333
Clothing 32,153 3,385
Other manufactures 1,01,972 24,231
Other products 592 295
Other 1,731 2,712
Source: Director General of Trade, European Commission

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 THE ANALYSIS
6
There is little historical precedence to show the extent to which
carbon pricing measures lead to carbon leakage, and there is no
widely agreed-upon understanding of how border carbon adjustments
can effectively prevent carbon leakage.

With relatively greener production in rich countries, the competitive

disadvantage posed by CBAM transfers the burden of decarbonisation
onto developing nations.

An overemphasis on pushing for carbon pricing via CBAM overlooks

the significance of non-pricing efforts made by countries to reduce
carbon emissions.

The WTO rules were designed to remove trade barriers and

establish a system of rules that promote open, fair, and undistorted
competition. This seems counterintuitive to the concept of
CBAM-like measures.

If climate considerations are to permeate trade agreements, and vice

versa, upholding the principles of CBDR or special and differential
treatment is crucial. Without this, developing countries may
increasingly find their exports curbed on climate grounds.

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 THE ANALYSIS

No historical precedence for carbon leakage

The primary motivation behind implementing CBAM is to counter the effects of
anticipated carbon leakage once free allowances for industry are phased out under
the EU ETS. It could be argued that so far, the EU has prevented leakage through
the distribution of free allowances and not covering a large section of the industrial
sector in the pricing mechanism. According to Sanjay Reddy, chair of the Department
of Economics at the US-based New School for Social Research, as per the standard
economic theory of trade, imposing carbon taxes on domestic producers without
an adjustment mechanism would certainly cause a shift of production to places
where those taxes can be avoided.23 An adjustment mechanism, therefore, causes
the environmental benefits of the carbon tax to be felt more broadly and may spur
foreign producers to undertake carbon abatement measures.

Yet, since the EU ETS is one of the first of its kind, there is little historical precedence
to show the extent to which carbon pricing measures lead to carbon leakage, and
there is no widely agreed-upon understanding of how border carbon adjustments
can effectively prevent carbon leakage.

Carbon leakage occurs when companies shift production outside their regions due
to increased production costs triggered by policies, or when domestic firms lose
market competitiveness to foreign firms exempt from the same policy burden.
The argument regarding carbon leakage due to carbon pricing policy is not
straightforward or unequivocal. Establishing a direct causal link between a carbon
price and leakage is complex, as it is influenced by various factors beyond policy
intervention, like trade patterns and supply chain dynamics.

Carbon pricing may not directly influence decisions to shift production; there are
costs associated with relocation, including fixed costs and the opportunity cost of
leaving the home region, resulting in a loss of market share and brand presence.
Therefore, companies may not base their decisions solely on price indications.
Additionally, according to the Porter Hypothesis put forth by Harvard University
economist Michael Porter in 1991, pricing instruments may stimulate innovation
and productivity, potentially offsetting the costs of carbon payment.24 On the other
hand, carbon pricing may influence new investment decisions — investments
shifting abroad — but this would remain harder to distinguish and establish.

Empirical studies searching for evidence of leakage from existing climate policies
have had limited success.25 More specifically for carbon pricing policies, research
has mostly found little impact on carbon leakage, especially for the European
Union.26,27

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 Numerous computer modelling analyses do predict leakage under a pricing
regime, like the EU ETS. However, these studies exhibit significant differences in
their estimations of carbon leakage rates, ranging from 2 per cent to as high as 54
per cent.28,29 A leakage rate of say 50 per cent indicates that half of the emission
reductions achieved in the EU might be offset by emissions elsewhere.

The effectiveness of border carbon adjustment to curb carbon leakage has also been
the subject of some modelling exercises. A 2012 study on the impact of carbon-
based import tariffs on emission-intensive sectors found that such policies could
cut leakage by a third.30 The same study noted the shift in the economic burden on
other countries, particularly a deterioration in the terms-of-trade of the exporting
country. Terms-of-trade is a ratio of the price index of a country’s exports to the
price index of the country’s imports. It indicates how much a country is earning
through its exports relative to its payment for imports.

Transferring the burden to the poor

Who pays for decarbonisation?

For the levying country, a CBAM may be seen as levelling the playing field for
its firms paying the domestic carbon price. However, for exporting countries, it
increases costs in the short and medium term, and this is harmful, particularly for
developing countries which depend on export revenues.

When viewed in the context of recent trade and industrial history where carbon-
intensive production has proliferated in the Global South, much of which still
depends on coal as a fuel, there is a clear violation of the principle of common but
differentiated responsibilities (CBDR) enshrined in the Paris Agreement and the
UNFCCC.

According to UNCTAD: “in today’s interconnected global economy, the

organization of global production through global value chains (GVCs) has caused
many carbon emitting production activities to be shifted to developing countries,
while associated low-carbon pre-production and post-production activities have
been retained by the lead firms and mainly based in the developed countries. The
comparative energy efficiency in the North therefore cannot be de-linked from the
energy inefficiency in the South. This implies that measures such as Cross Border
Adjustment Mechanisms (CBAM), which impose carbon tariffs on imports from
developing countries into developed countries, cannot be evaluated independently
of these structural conditions.”31

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 THE ANALYSIS

Graph 10: Percentage share of global manufacturing by value-added

South and East Asia’s share nearly doubled in two and half decades

1990 40 24 24 6 6

1995 34 25 28 7 6

2000 33 26 29 6 6

2005 30 25 33 6 6

2010 26 21 41 6 6

2015 24 20 45 5 6

Europe North America South/East Asia Latin America Rest of world

Source: BCG analysis of UNIDO data

With relatively greener production in rich countries, the competitive disadvantage

posed by CBAM transfers the burden of decarbonisation on to developing nations.
Consider the example of the production of iron and steel and aluminum (see Graph
11). Emissions intensity per tonne of production is generally high in developing
countries compared to advanced economies — implementation of CBAM could
put developing countries at a competitive disadvantage.

Recognising the principle of differentiated responsibility, the Paris Agreement

designates developed country Parties to lead efforts in reducing emissions.
Furthermore, it emphasises the need for the developed world to extend financial
and technological support to the developing world, aiding them in their mitigation
efforts. This core tenet implies that countries are not held to uniform standards of
punitive measures or carbon pricing mechanisms, contrary to the idea of the same
level of carbon pricing regimes in partner countries that the European Union
hopes to encourage through CBAM.

Moreover, decarbonisation in exporting countries’ manufacturing sectors requires

economy-wide mitigation pathways coupled with adequate and sustained
internationally mobilised financing to enable those efforts. A carbon border tax
imposed on select sectors — currently equivalent to only 1.64 per cent of India’s
total exports — amounts to an additional tax burden and trade barrier, and no
more. It is unlikely to incentivise decarbonisation in jurisdictions outside the EU,
especially when developing countries are expected to fund this entirely through
their domestic budgets and without explicit stated support from the EU.

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 Graph 11: Emissions intensity of crude steel production (i) and primary
aluminium production (ii)
Emission intensity of both crude steel and primary aluminium is high for India and China, among major
producers

tCO2/t Crude Steel tCO2/t Primary Aluminium

0 5 0 5 10 15 20

Ukraine 2.4 India 15.1

India 2.1 China 12.4
China 2.0 Australia 11.3
Vietnam 1.9 USA 7.5
Japan 1.9 UAE 7.4
Brazil 1.7 Russia 7.2
South Korea 1.6 Bahrain 7.1
Russia 1.5 New Zealand 3.0
Germany 1.4 Norway 2.1
France 1.4 Canada 2.1
Canada 1.2 Iceland 1.2
Mexico 1.0
Turkey 1.0
Note: Other sources, such as CRISIL, report the carbon intensity for primary aluminium production
U.S. 1.0
to be 21-22 tCO2/t for India and 17.5-18.5 tCO2/t for China. India's Ministry of Steel provides the
Italy 0.8 emission intensity of the Indian steel industry to be 2.5 tCO2/t. Hence, estimates may vary.
Source: Global Efficiency Intelligence

Administrative burden
The CBAM may also be seen as a non-tariff barrier if its implementation imposes
excessive administrative burdens, discriminates among exporting companies, or
disproportionately affects certain industries or countries.

These concerns could arise if CBAM’s requirements for measuring and verifying
carbon content are overly complex, or if it applies different standards to goods from
different countries. At the moment, measuring emissions requires skilled capacity,
resources, sophisticated frameworks and benchmarks, putting a significant burden
on developing economies.

India’s micro, small, and medium enterprises (MSME) sector made up 43.59 per
cent of exports from India in the Financial Year 2023 — having declined over the
years from 49.77 per cent in 2020 and 45.03 per cent in 2022.32 With declining
export share and additional measurement and reporting requirements, smaller
enterprises would suffer setbacks and struggle to keep pace without sufficient
assistance and handholding.

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 THE ANALYSIS

The EU has gained considerable expertise in monitoring, reporting, and verification

(MRV) practices through its experience with the ETS, which has spanned over
a decade and a half. This stands in stark contrast to non-ETS countries, where
similar capacities are lacking. Consequently, this presents another challenge for
developing nations to align with CBAM.

Limitations of carbon pricing

Equivalence of methodology
According to the European Commission, if a company pays a carbon price in the
country where the goods originated, they can claim a reduction in the number
of CBAM certificates they need to surrender. However, they can only do this if
they have “effectively” paid the carbon price, and any rebate or compensation
options provided in that country, which would have lowered the carbon price,
will be considered. The CBAM regulations leave it to the Commission to adopt an
implementing act to detail out how the price would be considered.

The regulation does define a carbon price, though. It says: “‘Carbon price’ means
the monetary amount paid in a third country, under a carbon emissions reduction
scheme, in the form of a tax, levy or fee or in the form of emission allowances
under a greenhouse gas emissions trading system, calculated on greenhouse gases
covered by such a measure, and released during the production of goods”.

Different countries or regions may have varying methodologies for verifying carbon
emissions. Ensuring equivalency across these diverse systems poses a challenge.
Essentially, the concern is about how to standardise or reconcile the different
methods in different countries. In some countries, different sub-national regions
may have their own carbon pricing regimes, adding another layer of complexity.

Overlooking non-carbon pricing policies

Moreover, an overemphasis on pushing for carbon pricing overlooks the significance
of non-pricing efforts made by countries to reduce emissions. In CBAM, there is
a lack of acknowledgement for these non-pricing initiatives in partner nations,
which not only undermines their effectiveness but also disincentivises the adoption
of alternative decarbonisation measures beyond carbon pricing. Take, for example,
targets for non-fossil power capacity that India has instituted under its NDC, or
subsidies to promote electric vehicle adoption for decarbonising the transport
sector.

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 Lack of fairness in carbon pricing
The arguments above bring us to the fundamental question of fairness — carbon
prices have been known to be regressive in situations where there is high income
inequality and relatively higher carbon intensity in targeted sectors. This can be
mitigated to some extent through recycling revenues back to affected entities
or communities.33 In the case of CBAM, developing countries have much lower
GDP per capita than the EU and more carbon-intensive manufacturing sectors.
Imposing an equal carbon price across all economies can, therefore, be viewed
as unfair due to the distributional impacts and the likelihood that the costs of
decarbonisation may vary across countries. Given that there is no provision for
recycling CBAM revenues back to the exporting countries, the imposition of the
tax serves to perpetuate existing inequalities further.

Even with a functional domestic carbon pricing mechanism, the price in developing
countries is unlikely to match that of the EU market, since most firms in developing
countries cannot compete if subjected to excessively high carbon prices. This also
occurs if and when the EU recognises a third country’s pricing regime as “effective”,
as per its rules. Therefore, even with a domestic carbon pricing scheme in place, a
country may still bear a substantial tax burden.

Another question to ask is if developing countries must pay a carbon price of

approximately €100/tCO2e for their exports to the EU, what is the justification for
companies in developed countries purchasing offsets from developing countries at
carbon prices as low as €1/tCO2e?

CHEAP OFFSETS FOR EU, HIGH CARBON PRICES FOR EXPORTERS

Participating entities in the EU ETS were able to use international carbon credits from the Clean
Development Mechanism (CDM) and Joint Implementation (JI) to meet up to 50 per cent of
their emission reduction obligations. Between 2008 and 2020, therefore, the limit was set at 1.6
gigatonne of CO2eq to be compensated for by international carbon credits; 1.058 billion carbon
credits were used up during the second phase itself, between 2008 and 2012. The price of CDM
credits during the same period hovered around €10 to €15, falling further after that period
before eventually collapsing around 2013. The use of offsets was not allowed from the
beginning of phase IV.

In sectors not covered under the ETS, voluntary offsetting of emissions is permitted. It was only
in 2023 that an EU directive banned claims of carbon neutrality based solely on the purchase of
offsets. Thus, for a long time, the system benefitted from cheap carbon offsets bought from other
parts of the world, mostly developing countries. Even today, outside the ETS, European companies
continue to claim climate benefits with the purchase of voluntary carbon credits for as cheap as €1
from the developing world.

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 THE ANALYSIS

It is important to challenge the imposition of a high carbon price on exports from

developing countries while simultaneously allowing developed countries to offset
their emissions at much lower prices through purchasing carbon credits from
(often) the same developing countries. It highlights a potential inconsistency in
the global approach to carbon pricing and emission reduction efforts.

International trade order and CBAM

Trade rules
The inclusion of CBAM within the EU regulatory framework has sparked debates
regarding its conformity with the existing rule-based international trade order. The
World Trade Organization (WTO) rules, for instance, were framed to remove trade
barriers: “a system of rules to allow open, fair and undistorted competition”34.
Even though the EU asserts its commitment to implementing a CBAM that aligns
with WTO principles, disputes are expected.

Examining the legality of CBAM within the WTO regime necessitates an analysis
of several pertinent agreements, notably the Technical Barriers to Trade (TBT)
Agreement and the General Agreement on Tariffs and Trade (GATT). A legal
assessment of CBAM conducted for the European Parliament’s Committee on
International Trade outlines the following aspects.35

Under the TBT Agreement, which aims to harmonise technical regulations

worldwide, CBAM must ensure that its implementation does not create undue
hindrances to international trade by technical regulations, standards and
conformity assessment procedures.

Within the framework of the GATT, CBAM may be examined under several key
principles. Tariff bindings dictate that the EU must establish a maximum import
duty rate per product. This prevents a tariff from exceeding the maximum import
duty or tariff fixed for a product. However, the same GATT rules also permit
adjustments tax on imports akin to internal taxes, provided they correspond to
domestic taxes. GATT also prohibits quantitative import restrictions; thus, if
CBAM were construed as a border restriction limiting imports rather than an
import tariff or internal tax, it could potentially violate this provision.

National Treatment mandates that there should be no discrimination against

imported goods compared to domestic products of like nature. If the border tax
is construed as an indirect tax on both domestic products and imported products,
and not as a tariff on imported products, it must ensure that it does not afford
‘protection to domestic production’.

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 The Most Favored Nation (MFN) principle requires equal treatment for all WTO
members, necessitating non-discrimination between similar products imported
from different countries. The production process is immaterial here. For example,
aluminum product from China cannot be treated differently from aluminium
imports from the US. Thus, CBAM could likely be violative of the MFN principle.

If CBAM is found to violate any of these principles, it can still be considered for
exceptions under GATT rules on health and environment, where such measures
could be considered exceptions if they are “necessary to protect human, animal, or
plant life or health”.

Regarding exemptions for developing countries, WTO law allows for special and
differential treatment (SDT) to accommodate differing economic capacities.
CBAM exemptions for these countries must navigate legal intricacies, including
consideration of the Enabling Clause, which permits developed nations to offer
preferential trade benefits to developing countries without contravening the MFN
principle.

India, China, South Africa and several other countries have questioned the
compatibility of CBAM with WTO rules and are continuing to raise concerns with
the trade body.

Expansion of CBAM and a retaliatory trade war

Currently, CBAM has been rolled out and institutionalised only by the EU; it is
limited to a few sectors — therefore, its impact is limited in the near term. However,
an implementation of CBAM by other countries and its expansion to economy-
wide trade will exponentially increase its adverse impacts on exporting countries,
and potentially lead to a trade war. Both outcomes are not in the best interests of
multilateralism and international cooperation, which are the needs of the hour.

Following the EU’s lead, the UK has unveiled its own Carbon Border Adjustment
Mechanism (CBAM), scheduled to take effect in 2027. Meanwhile, the US is
contemplating a suite of new regulations, including the PROVE IT Act, Foreign
Pollution Act, Clean Competition Action, and the Market Choice Act. These
regulations aim to scrutinise the carbon intensity of production, impose fees on
emission-intensive imported goods, levy carbon intensity charges on both domestic
and imported products and impose taxes on fossil fuel combustion and imports,
respectively. Other countries have also been mulling border taxes and retaliatory
measures to counter the EU’s CBAM.

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 THE ANALYSIS

Graph 12: Computable general equilibrium modelling (CGE) analysis of GDP

decline under joint CBAM implementation and assumed carbon price of €40
It predicts a decline in African and Indian economies by 0.73 per cent and 0.69 per cent, respectively

Source: African Climate Foundation and LSE

The African Climate Foundation models a scenario of joint implementation of

CBAM by a set of countries, namely the EU, US, UK, Canada, and Japan, with a
carbon price assumption of €40. It predicts a decline in the African and Indian
economies by 0.73 per cent and 0.69 per cent, respectively, with a corresponding
fall in CO2e emissions of 0.39 per cent and 0.34 per cent, respectively.

Trade and climate linkage

An overarching consideration that includes but is not limited to CBAM as a policy
tool, is the convergence of the trade and climate agenda, and whether trade is a
domain through which countries must enforce greater climate ambition.

Historically, developed countries have sought to merge trade and environmental

considerations, arguing that “the multilateral trading system and the environmental
regime are mutually supportive”.36 Critics have argued that this approach seeks
legal grounds to impose trade restrictions on developing countries on the grounds
of environmental concerns. Thus, even if the restrictions do not significantly
address environmental problems — or carbon emissions in the case of CBAM —
developing countries would find it difficult to legally challenge them, and their
exports will also suffer.

Developing countries distrust the developed countries’ endeavor to link environment

and trade, their fear being that trade/environment linkages are sought for purely

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 protectionist reasons.37 To that extent, UN Convention on Climate Change has
specified that “measures taken to combat climate change, including unilateral
ones, should not constitute a means of arbitrary or unjustifiable discrimination or
a disguised restriction on international trade”.

In 1998, Anil Agarwal of CSE had argued against the use of trade sanctions on
environmental grounds, stating that “only economically powerful nations can
impose effective trade sanctions against less economically powerful nations. This
tool for bringing environmentally errant nations to task cannot be used by less
economically powerful nations against the global economic powers, howsoever
bad their environmental track record might be. There can be no doubt that there
is today a need for a system of global environmental governance, but this system
must be built on rules, regulations, tools and modalities that are fair, just and
equally accessible to all”.38

Yet in an increasingly climate-risked world, the lines are getting blurred, especially
considering that carbon emissions produced locally have a global warming impact
and do not restrain themselves within territorial borders.

While the EU is implementing CBAM, the US is constituting a new Climate and

Trade Task Force to address “carbon leakage, carbon dumping, and embodied
carbon in general”.39 The US signals intent to work with trade partners to develop
standard methods to measure emissions, lower costs of clean technologies, and
help developing countries secure capital needed to decarbonise industry.

Carbon is not the only consideration here, and thus the US’s statement does not
come without caveats: the provisions will be extended to “like-minded” countries,
a continuation of the strategy of “friendshoring” to counter China’s dominance of
manufacturing as well as the new green supply chains (see Graph 13 and 14).

In this war for economic supremacy between the G2 — the US and China — and
the EU’s role as a frontrunner in climate policy and a marketplace for goods,
developing countries must determine their role.

If climate considerations are to permeate trade agreements, and vice versa,

upholding the principles of common but differentiated responsibilities (CBDR)
and special and differential treatment (SDT) is crucial. Without this, developing
countries may increasingly find their exports curbed on climate grounds, and
simultaneously become buyers of green technologies produced in the Global
North.

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 THE ANALYSIS

Graphs 13 and 14: Share of global manufacturing value added (%) and Clean
energy manufacturing capacity by location
China dominates global manufacturing and supply of green goods

Source: Financial Times, World Bank

Source: BloombergNEF

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 Additionally, the CBAM aims to prevent carbon leakage by imposing tariffs on
imports from countries with less stringent carbon pricing. However, this can
negatively affect developing countries by imposing economic burdens and
intensifying technological disparities, thus falling under the UNFCCC's mandate
to consider the economic and social consequences of climate response measures
on all Parties, especially the developing countries, under what is called the ‘impact
of the implementation of response measures’ in the UNFCCC process.

The UNFCCC defines the impact of the implementation of response measures as

“the effects arising from the implementation of mitigation policies, programmes,
and actions, 'in-jurisdiction' and 'out-of-jurisdiction' or cross-border impacts, taken
by Parties under the Convention, the Kyoto Protocol, and the Paris Agreement to
combat climate change.”

Article 4.8 of the UNFCCC further states, “In the implementation of the
commitments in this Article, the Parties shall give full consideration to what
actions are necessary under the Convention, including actions related to funding,
insurance, and the transfer of technology, to meet the specific needs and concerns
of developing country Parties arising from the adverse effects of climate change
and/or the impact of the implementation of response measures.”

In fact, at Doha in 2012, some developing countries had advocated for including
the following in the outcome document: “Decides that developed country Parties
shall not resort to any form of unilateral measures against goods and services from
developing country Parties on any grounds related to climate change, including
protection and stabilization of the climate, emissions leakage, and/or the cost of
environmental compliance.” But this was opposed by developed countries and did
not become apart of the outcome.

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 TPP COMPLIANCE STATUS WITH SOx NORMS

THE WAY FORWARD

7
CBAM is expected to generate about €1.5 billion in revenues per
year. The EU should set aside this revenue to aid the decarbonisation
of manufacturing in developing countries.

Developing countries may consider a domestically collected carbon

tax at the point of exports rather than having to pay the tax to EU.

Industries in emerging economies could diversify production

processes and direct exports to suit the demands
of different markets.

Countries that have not contributed historically to the climate crisis

may also consider imposing a ‘historical polluter fee’ on trade
partners to fund their decarbonization.

To demand the recycling of CBAM revenues or sector-specific climate

finance, it is essential that developing countries also have sectoral
mitigation plans in place.

42

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 T
he EU’s CBAM is one among several policy tools that have been initiated in
this decade, that appear to further the cause of climate protection but carry
with them telltale signs of trade protectionism and economic nationalism.
Many of these policies have been driven by developed nations in response to the
perceived threats of de-industrialisation, and carbon leakage due to relatively
stricter domestic climate policies in their jurisdictions as compared with some
developing countries.

As a result, many of the principles of the regime of free and open trade that have
been held as gospel for the past three decades by the same developed nations, are
being tested or outrightly rejected by these policies.

The free trade regime in itself, “has not led to decreasing poverty or inequality; in
fact, it has led to market concentration, vast inequalities, instabilities in the global
economy, and challenges in ‘just in time’ supply chains as we have seen during
the pandemic”40. Facilitating a shift towards a more globally just trade regime is
crucial, but that may be a decades-long process. In the interim, the impacts of the
above policies must be minimised so that the developmental process in the Global
South is not hindered.

In parallel, a cooperative, justice-oriented approach to decarbonisation needs to

be envisioned alongside these short- and long-term discussions on trade. This is
to ensure that countries of the Global South can meet their developmental goals
through low-carbon, climate-resilient pathways.

Recommendations for EU’s CBAM

Set up a decarbonisation fund for developing countries

The EU’s own estimates suggest that the CBAM is expected to generate about
€1.5 billion in revenues per year.41 The EU should set aside this revenue to aid
decarbonisation of manufacturing in developing countries as a necessary step.
Shifting to low-carbon processes demands substantial financial resources and
technological advancements, resources that many developing countries currently
lack. Pinning hopes solely on internal carbon pricing mechanisms within
developing nations to drive their decarbonisation overlooks their limited structural
capacity for such transitions, and also places the burden of financing the transition
squarely on them.

The EU is responsible for 22 per cent of historical CO2 emissions42; expecting

developing countries to achieve decarbonisation without robust support is both

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 THE WAY FORWARD

unrealistic and unjust. For this, the EU can set up a fund similar to its Modernisation
Fund that is financed with the ETS revenue and is spent on clean energy in 13
lower-income EU Member States.

Channelise additional climate finance

Additionally, the EU must be pressed to commit to increased flows of climate finance
towards developing countries. This is not just a matter of fairness, but a pragmatic
recognition of the challenges these nations face in achieving decarbonisation. The
EU as a bloc is already collectively one of the largest contributors to climate finance,
but the imposition of unilateral tax pressures like CBAM require additional,
targeted, sector-specific financing towards the carbon-intensive manufacturing
sectors in exporting developing countries.

Exempt least developed countries from tax burden

The EU must commit to exempting the most vulnerable countries from bearing
any CBAM liability for such a period of time as it takes to decarbonize their
manufacturing sectors, boost green industrialization, and improve quality of life
for their citizens. This should apply to least developed countries (LDCs) and small
island developing states (SIDS) exporting to the EU.

Recommendations for developing countries

Developing countries must be proactive and must adapt to a changing trade regime
in the era of climate change. The following measures can be considered.

Collecting a carbon tax domestically to avoid being

taxed in Europe
The country, say India, may consider a domestically collected carbon tax at the
point of exports. Rather than subjecting industries to the tax imposed by the EU,
it could institute a domestic carbon tax specifically targeting exports of CBAM
products destined for the EU market or any country imposing a carbon border tax.

This would meet the CBAM’s criterion of a domestic carbon pricing mechanism
being present in the exporting country. Under this framework, revenues generated
from the domestic carbon tax could be channeled into a government-managed
decarbonisation fund. This fund could serve the purpose of retaining tax revenues
within India and supporting the decarbonisation efforts of Indian industries.

One key feature of this approach is the provision of rebates to industries based on
their export activities from the decarbonisation fund. Industries can apply to access
full or viability gap funding from the fund for specific decarbonisation projects.

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 Implementing a domestically collected carbon tax allows India to assert
greater control over its mitigation pathways and to achieve decarbonisation
where it is best possible, rather than relying on external regulatory measures
imposed by trading partners. This way, the country can address carbon emissions
within its borders.

Differentiated production processes and trade partners

From a production and trade perspective, industries in emerging economies could
diversify production processes and direct exports to suit the demands of different
markets, as a short to medium term measure. Allocating green production
processes to goods destined for regions imposing a CBAM could be an interim
step while the country’s manufacturing sector gradually decarbonises.

This would mean reserving less carbon-intensive production for markets that
prioritise environmental considerations over price. Industries can thus achieve
multiple objectives: engineering industrial outputs to minimise the costs of
CBAM-like measures and buying time to decarbonise overall at a fairer pace.

Consider the example of a steel manufacturing company which produces steel

using the two main processes: the Direct Reduced Iron (DRI) process, known for
its lower carbon emissions, and the more traditional Blast Furnace (BF) process,
which generates higher carbon emissions. For exports destined for the EU market,
where stringent carbon regulations are in place, the industry could allocate its
DRI process for steel production. On the other hand, for markets where price
considerations outweigh environmental concerns, the industry could continue to
utilise its Blast Furnace process in the short to medium term.

This strategy recognises the fact that not all markets prioritise environmental
considerations equally and allows industries to maintain their market share in
regions where cost is the primary driver of purchasing decisions.

In practice, these dual supply chains may be a challenge to implement at scale, but
they can be considered where feasible.

Developing countries must have sectoral mitigation plans

To demand recycling of CBAM revenues or sector-specific climate finance, it is
essential that developing countries also have sectoral mitigation plans in place.
These plans should outline specific measures and targets for emissions reductions
within key emitting sectors of their economies. This is essential to align their

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 THE WAY FORWARD

domestic strategies with their unique needs and avoid the impact of top-down
prescriptions from the international community which may fund solutions not
appropriate for them. By aligning climate finance with these sectoral mitigation
plans, the EU could be assured that its support is targeted and impactful,
maximising the effectiveness of its financing for decarbonisation efforts.

Collecting a historical polluter tax

Countries that have not contributed historically to the climate crisis may also
consider imposing a ‘historical polluter fee’ on trade partners to fund their own
decarbonisation. This could be imposed on a trade partner if they are responsible
for a certain share of cumulative historical CO2 emissions since the pre-industrial
period. A carbon border tax being imposed by the trade partner may also be a
consideration.

Other considerations could be as follows: the tax could be imposed on select

products as determined by the country, to generate funds to decarbonise the
sector. The level of the tax could be ascertained based on the historical emissions
of the trade partner. One way to do this is to impose the same percentage tax on
the value of imports as is the share of historical emissions — in the case of the EU,
this would be 22 per cent levied on the value of imports.

WHY SHOULD THE CBAM BE MET WITH A HISTORICAL

POLLUTER TAX?

As established in the last chapter, historical trends have shown that carbon-intensive production
has shifted from developed to developing countries. This historical relocation of industries has
led to disparities in emissions intensity between countries. Differences in emissions intensity of
production today also have links to the question of historical emissions — the Global North utilised
fossil fuels like coal in the early stages of the Industrial Revolution, which enabled it to amass
wealth and grow its economies. The former colonies of the Global South are hoping to do the same
today — particularly through the growth of their manufacturing sector — and with the use of
affordable energy, which in many cases is coal. Consequently, the emissions intensity of current
production processes is intricately linked to past emissions trajectories.

The imposition of a CBAM inherently neglects this historical trend and penalises the Global South.
It is, therefore, not a retaliation, but a course correction that the South should be allowed to
impose a cost on the North for years of cheap polluting energy use, offshoring, and the use of cheap
offsets. By implementing a tax that accounts for historical emissions, nations can address the
imbalance in responsibility, and inherent unfairness in CBAM.

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 7
ANNEXURE

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 ANNEXURE

Snapshot of emission calculations for CBAM post-2024

Example of emission calculation for the making of a steel slab

Consumption Activity Emissions Emissions (tCO2) Assumptions
data (tonne) factor
Steel scrap (market) 15,00,000 0 There are no embodied emissions
for scrap
FeMn (31% Mn) 3,00,000 1.5 4,50,000 Get the emissions factor from
supplier
FeNi (28% Ni) 3,00,000 3.4 10,20,000 Get the emissions factor from
supplier
Graphite electrodes 5,000 3 15,000 Direct emissions from carbon in
the product
Lime 1,00,000 0.5 50,000 Lime EF from database
Crude steel (purchased) 80,000 1.8 1,44,000 Get the emissions factor from
supplier
Total direct emissions of 22,85,000 16,79,000
Installation
Total electricity 20,00,000 0.833 16,66,000 Choice of standard values or local
consumption (MWh) grid emission factors
FeMn (31% Mn) 3,00,000 2 6,00,000 Direct emissions from carbon in
the product
FeNi (28% Ni) 3,00,000 3 9,00,000 Get the emissions factor from
supplier
Total indirect emissions 26,00,000
of Installation 31,66,000
Total crude steel slab 2,234,000 16,79,000 + EF = .75 | 1.42
produced 31,66,000
Source: Carbon Chain

Example of calculation for making aluminium ingot

Material inputs (no embodied emissions) Energy inputs

Alumina Electricity CO2

No EF EF: 0.28088 kg 63,2000 t CO2
CO2JkWh (process
emissions
Pre-baked anodes only)
97.7% C

SMELTER Aluminium
Soda ash ingot
11.3% C

Natural Gas
CF4 & C2 F6
Cryolite NCV: 28 Tj/Gg
6,250 t CO2 e
No EF EF: 56.1 t CO2/TJ

Source: Carbon Chain

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 Fuel related emissions from EU default values
Electricity — Public data set from producer country
For process CO2 emissions — using a mass balance approach
For PFCs — methodology described by EU

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 TPP COMPLIANCE STATUS WITH SOx NORMS

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 The European Union's introduction of the Carbon
Border Adjustment Mechanism (CBAM) marks a
bold new experiment in global trade and climate
policy. By taxing imports like iron, steel, cement,
and aluminium based on their greenhouse gas (GHG)
emission intensities, the EU aims to level the playing
field for its firms operating under the Emissions
Trading System (ETS).

However, the impact of CBAM is likely to be

disproportionately felt by developing countries,
potentially hindering their economic growth in
key sectors and access to global markets. At the
28th Conference of Parties in 2023, developing
countries had raised concerns about the negative
impacts of unilateral trade measures like CBAM on
their economies. Does the CBAM truly spur global
decarbonisation, or does it perpetuate existing
inequalities and trade tensions?

This new report by CSE — the first in a research

series titled ‘Trade and Climate: The Global South’s
response to a changing trade regime in the era of
climate change’ — explores answers to this question.

Centre for Science and Environment

41, Tughlakabad Institutional Area, New Delhi 110 062
Phones: 91-11-40616000 Fax: 91-11-29955879
E-mail: cseindia@cseindia.org Website: www.cseindia.org

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