EU Wants To Make ‘Carbon Tariff’ Mandatory For Imports. It Will Hit Developing Countries Hard

When the nations of the world meet for COP29 — or the 29th Conference of the Parties (COP) of the United Nations Framework Convention on Climate Change (UNFCCC) — in November, the topics under discussion will include the European Union’s (EU’s) ‘carbon tariffs’.Since 2023, the EU has been running a ‘pilot’ for a ‘Carbon Border Adjustment Mechanism (CBAM)’, which it describes as a “tool to put a fair price on the carbon emitted during the production of carbon intensive goods that are entering the EU, and to encourage cleaner industrial production in non-EU countries”. The idea is to prevent ‘carbon leakage’, and ensure the EU’s carbon restrictions are not undermined by imports from countries with less stringent policies. The EU has described the current run as “transitional”, saying the system will kick in fully in 2026.The CBAM currently applies to imports of “certain goods and selected precursors whose production is carbon intensive and at most significant risk of carbon leakage: cement, iron and steel, aluminium, fertilizers, electricity and hydrogen”. While a laudable initiative, there are significant concerns regarding the CBAM with respect to its impact on developing countries. Notably, it doesn’t take into account the global understanding — under the UNFCCC no less — that while climate change is a shared responsibility, the onus of fighting it is not shared equally by nations, and rests more on developed countries because of their historical contributions to emissions.What Is CBAM, And Why The WorryThe COP is the supreme decision-making body of the framework, and monitors its execution and progress. Reducing emissions to fight climate change is among the COP’s focus areas, and from here emerged the ‘ESG (Environmental, Social and Governance)’ concept to assess the sustainability efforts of businesses. Under this framework, a company’s efforts towards reducing environmental damage and other environment-related concerns have now become a part of board discussions. The EU’s CBAM goes a step ahead. Among other things, it makes it mandatory for suppliers to report emissions data. It addresses carbon dioxide or CO2 emissions, and not the holistic environmental impact of the manufacturing processes employed by a supplier. Global warming and climate change at large are definitely a shared concern, but each country has listed out its acceptable norms of emissions and pace to achieve the same. There is an additional cost to being CBAM-compliant, which requires necessary priority investments and correction in production flow charts. One needs to map the obligations, conduct impact assessment, and engage professional teams to calculate the embedded emissions. The CBAM has a laudable aim. It is a mechanism to ensure a level playing field to local producers — who are governed by the EU’s Emissions Trading System (ETS) and thus have to pay tax for greenhouse emissions — against imports from countries that have not yet resorted to stringent emission regulations like the EU. It is a policy tool aimed at reducing carbon emissions by ensuring that imported goods are subject to the same carbon costs as products produced within the EU. The EU has taken leadership in mainstreaming ESG concerns in governance, especially those pertaining to CO2 emissions, and, among other things, the move aims to bring the manufacturing of the designated goods to levels admissible in the EU and accelerate the pace of climate-change investments in the supplier countries. While the World Trade Organization (WTO) is restricted to trade practices, the CBAM incorporates environmental concerns that are at the centre of Sustainable Development Goals (SDGs).The informal G7 grouping of countries — Canada, France, Germany, Italy, Japan, the UK and the US — as well as the EU support the CBAM.Even so, the CBAM is a non-tariff barrier in trade in terms of an indirect tax. There are concerns that its execution across COP member countries could lead to developing and underdeveloped economies, especially those in Africa, prioritising CBAM compliance in the allocation of their limited resources over other growth concerns. The other objection is that CBAM is in violation of the ‘Common-but-differentiated-responsibilities (CBDM)’ principle agreed upon in the Paris Agreement and the UNFCCC. Here, the responsibility of the required investment fully lies on the supplier country, and impacts the trade volumes exported to the EU. The price of goods imported by the EU will also go up as the tax will be incorporated in the cost. The mandatory CBAM requirement appears to be at the cost of global welfare, and in violation of equality principles.What Needs To Be DoneThe import CBAM is levied on carbon-intensive products, based on the carbon footprint, adding to the costs for suppliers. For India, it is estimated to be 7-15% ad valorem duties on the listed EU Scope 2 emissions (indirect emissions from the generation of purchased electricity etc). As yet, the electricity emissions are not a part of EU calculations. India, on the one hand, appreciates the EU’s concern, and is accelerating investments for reducing CO2 emissions. Proactive steps have also been taken by industry. Even so, India insists on making the CBAM a tool for contribution to global welfare costs, rather than being consumed within the EU. The different levels of transition to CBAM compliance — bringing in orientation, the preparation time, investments, integration in manufacturing goals, and synchronising them with other environmental concerns — is the path that the manufacture of designated goods needs to grow, but time needs to be provided for this to be achieved.The CBAM is a welcome trigger for sustainable manufacturing practices across the globe, but underdeveloped economies need to be handheld in the process, with documents of impact detailing the progress on a regular basis. That extra cost needs to be provided from the indirect tax collected under the CBAM, and this is what economies across the globe want. The author is a Practitioner Development Economist and retired Secretary to GoI.Disclaimer: The opinions, beliefs, and views expressed by the various authors and forum participants on this website are personal and do not reflect the opinions, beliefs, and views of ABP Network Pvt. Ltd.