By Anwarul Hoda
In May 2023, the European Union (EU) approved its regulation establishing a carbon border adjustment mechanism (CBAM). There were concerns in India that this would have a significant impact on exports to the EU. Calls were made to raise a dispute challenging the consistency of the measure with World Trade Organization (WTO) rules and take retaliatory action. But there are suggestions to seek a solution through bilateral dialogue too. The relative merits of the two options from India’s perspective are assessed in this article.
The disputes option
Starting 2026, the EU proposes to impose a carbon tax on imported goods on the basis of emissions during the production of goods in the exporting country. To begin with, the levy would apply to six energy-intensive and trade-oriented sectors — iron and steel, cement, fertilisers, aluminium, electricity, and hydrogen. Eventually, it would cover all sectors. As the EU takes measures to lower emissions, it is naturally concerned at the possibility of attempts by businesses to shift production to other, less demanding territories. The aim of the CBAM is to plug the loophole and prevent carbon leakage. Countries that export the covered products are doubly displeased because the EU has acted unilaterally.
Concerning the WTO remedies available to India, the WTO agreement permits members to impose customs duties and charges on imported products at the border, subject to two principal conditions. First, the same level of duties must be applied to similar or directly competitive products imported from other members. Second, the duty must not exceed the tariff binding of a member for that product. An important aspect of WTO rules is that the tariff binding does not affect a member’s ability to levy a separate charge equivalent to an internal tax imposed on a similar domestically produced item.
In the context of climate change, the question whether different levels of duty can be applied on similar products on the basis of emission of greenhouse gases during production has been raised. The conventional view in the General Agreement on Tariffs and Trade/WTO earlier has been that no distinction can be made on the basis of the process or production method in levying customs duty on similar products. However, this line of thinking has evolved and successive appellate body rulings in the WTO have permitted a distinction for legitimate objectives, based on methods of production. In a WTO dispute, the CBAM is likely to withstand a challenge on this score. The consistency of the CBAM with the WTO rules, however, can still be called into question at least on two counts. First, the whole framework in the EU’s Emission Trading System on which the CBAM is based involves regulation rather than imposing an internal tax that can serve as a benchmark for border adjustment. Second, since the CBAM cannot be justified as a tax equivalent to an internal tax, its imposition could result in a breach of tariff binding.
But these shortcomings of the CBAM will matter little in a WTO dispute. Article XX of GATT 1994 (General Exceptions) enables members to override all substantive rules spelt out in the mainstream provisions of the WTO agreement if measures are needed for certain public policy objectives. These include protection of human/animal/plant life, or health and conservation of exhaustible natural resources. Climate change-related policies are not specifically mentioned but are clearly encompassed by the exceptions on account of the objectives both of protection of health and conservation of natural resources.
Since the CBAM aims to stem carbon leakage, it is evidently linked to climate change and is shielded by the general exceptions from the application of substantive rules of the WTO agreement. A dispute challenging the CBAM will be of no avail.
The bilateral dialogue option
Our central objective in the bilateral talks should be the negotiation of a co-operative arrangement with the EU for dealing with the CBAM to minimise its adverse effects on exports. In the bilateral conversation, the imminent establishment of the Carbon Credit Trading System (CCTS) in India will give credibility to the country’s standing as a serious partner in reducing emissions and elicit a favourable response to our request for working out a way to lighten the CBAM burden on India. It would be reasonable to seek CBAM exemption from our exports up to the level achieved in a recent historical period, from the outset.
Questions may no doubt be asked of us about various features of the CCTS. It should not be difficult for us to explain why the targets for reduction are fixed in terms of the emission intensity of the GDP and why, to start with, only the large producers in four industrial sectors will be brought within the purview of reduction targets. The reduction trajectory may also figure in the talks and we are likely to be urged to scale up our efforts. In this context, we should ask for recognition that the carbon price that emerges from various features of the CCTS must perforce be at a much lower level than the prevailing price in developed countries, keeping in view the difference in per capita income. This may give us an opportunity to also ask for opening up a bilateral channel for the flow of finance and transfer of technology in accordance with the aims agreed to in Article 9 of the Paris Agreement. Both India and the EU will benefit greatly from a co-operation agreement on lowering emissions. India may be able to minimise the adverse effects of the CBAM and possibly open up a bilateral channel for the flow of climate-related finance and technology.
Meanwhile, the EU will be able to join in a co-operative endeavour with the world’s third-largest emitter to launch a concrete programme to reduce carbon emissions and enhance its leadership role in this critical area. Co-operation is the way forward.
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