The European Union’s carbon tax poses a new worry for India’s merchandise exports which are already grappling with a sluggish global economy, rising input costs and supply chain disruptions. This regulatory move is primarily aimed at protecting local European companies from being undercut by suppliers from countries with less stringent emission norms. However, it will increase the cost of compliance arising out of hiring energy auditors to estimate product-specific emissions and prepare the necessary documentation. That will cut into the profit margins of exporters.

Climate Policy Package

The European Parliament recently passed a Climate Policy Package which includes a proposal to impose a carbon tax on energy-intensive products such as cement, hydrogen, iron and steel and aluminium imported into the EU. The aim of this policy is to encourage the reduction of carbon emissions by making it more expensive to import these products. Thus, starting October 1, the foreign suppliers to the EU will have to report about greenhouse gas emissions embedded in their consignments, and from January 1, 2026, they’ll also have to pay for ‘carbon border adjustment’ that will jack up the cost of steel exports to the EU by 17-40 percent. It will hit as much as 27 percent of India's exports of iron, steel, and aluminium products worth $8.2 billion that are destined for the EU (2022). What is more worrying is that the carbon tax can potentially be extended to more products, and many other countries in particular, Canada, Japan, the UK and the US are also contemplating similar emission control moves.

The supporters of carbon tax legislation argue that it is part of the EU's efforts to reduce its carbon footprint and meet its climate targets. By imposing a carbon tax on imports, the EU hopes to incentivise countries outside of the EU to reduce their emissions, while also protecting local businesses that have already made efforts to reduce their carbon footprint. They also contend that the EU's Climate Policy Package (CPP) represents a major step towards a more sustainable future.

Non-tariff Barrier

In contrast, Indian companies - which are likely to be adversely affected by the border carbon adjustment mechanism - and a section of trade experts see it as a new form of non-tariff barrier to block the export of competitively priced merchandise from countries like India to EU. Media reports suggest that the Indian government is contemplating retaliatory measures, something similar to what it did to counter an increase in the import duties on India’s steel and aluminium exports to the US. However, any retaliatory actions by the Indian government in the form of increased import duties on European products will generate bad press, especially given India’s commitment to the Paris climate accord.

There are also suggestions to re-designate goods and services tax (GST) in part or full on steel and aluminium as a carbon tax to neutralise the adverse impact of the EU’s border carbon measures. This is a flawed argument as GST, being a domestic consumption tax, can’t be imposed on exports of made-in-India steel or aluminium. Besides, GST is also applied to imported products, so European steel or aluminium products coming into India can’t escape them.

Border Carbon Measures are WTO Compliant

Yet another option for India is to initiate a WTO complaint against the EU’s carbon tax while arguing that it’s a non-tariff barrier aimed at blocking imports to support competing domestic businesses. However, article XX (b) of the General Agreement on Trade and Tariffs (GATT) allows countries to implement trade restrictions, such as tariffs or quotas, that would otherwise be in violation of global trade rules, in order to protect the environment if they are applied to both imported as well competing domestically produced goods. In other words, border carbon measures are WTO-compatible.

Moreover, the EU may use the same tactics as India — for instance, in the WTO disputes with respect to India’s cane and sugar support measures, and the imposition of import duties on ICT products despite India being a signatory to the Information Technology Agreement — in defending its carbon tax by relying on the non-functional WTO Appellate System to avoid complying even if India wins at the panel level.

To conclude, there is not much that the Indian government can or should do to protect affected Indian businesses, except maybe signing FTAs with countries that have no plans to impose carbon taxes in the near future and help them diversify away from the developed countries. But that’s easier said than done. Besides, markets of developed countries in Europe and North America are too lucrative to let go. The Indian government can try to seek a longer transition period to comply with the European Union’s border carbon adjustment measures under its free trade deal which is currently under negotiation. But, that again will be difficult to pull off.

Against this backdrop, affected Indian companies can take a few proactive measures to prepare themselves for tougher emission control norms being imposed in their key export markets such as the EU or UK. For instance, increased reliance on cleaner renewable energy sources to power manufacturing units and to reduce their carbon footprints is one such measure. Steel makers can consider switching from blast furnaces to electric arc furnaces, and finally to green hydrogen that will help them minimise the damage caused by border carbon adjustments or carbon tax. That’s really the way forward.