The reporting period for the European Union's Carbon Border Adjustment Mechanism (hereinafter referred to as ‘CBAM’) initiated on January 31, 2024, mandated producers to comprehensively report all carbon emissions associated with their products. After the end of the reporting period, the producers are obliged to purchase CBAM certificates in proportion to embedded emissions in their products. This development is poised to adversely affect Indian exports to the European Union (EU), given the significant trade relationship where the EU stands as India's third-largest trading partner with a total trade of approximately 80 lakhs crore rupees (that is, €88 billion). Despite the substantial economic ties, CBAM implementation raises pertinent questions regarding World Trade Organization non-discrimination clauses, contraventions of international relations, and climate policy principles. While India has challenged the said scheme in the WTO, it remains to be seen whether the EU would adequately respond to the challenge or not. This blog delves into concerns such as violations of the Common But Differentiated Responsibilities Principle, arbitrary calculation methods, incompatible timelines, and potential implications of free-riding, and explores potential solutions to address these challenges.
PRINCIPLE OF COMMON BUT DIFFERENTIATED RESPONSIBILITIES AND RESPECTIVE CAPABILITIES (CBDR-RC)
The principle of Common But Differentiated Responsibilities and Respective Capabilities (CBDR–RC) is a foundational concept in global initiatives to address climate change. It is enshrined in the 1992 United Nations Framework Convention on Climate Change (UNFCCC) treaty, a document that has received ratification from all participating countries. CBDR recognizes that although every nation bears a responsibility in combating climate change, developed countries—historically the major contributors to greenhouse gas emissions—should shoulder a greater burden. The essence of this principle lies in tailoring commitments and actions to the unique circumstances of each country, taking into account their historical contributions and current capacities. CBDR guides international deliberations on setting emission targets, providing financial assistance to developing nations, and shaping the collective response to the challenges posed by climate change.
The 1992 UNFCCC echoes this principle, calling on developed nations to lead in addressing climate change. Similarly, The Seventh Principle of the 1992 Rio Declaration on Environment and Development emphasizes global cooperation with CBDR, attributing greater obligations to developed countries due to their significant contributions to environmental degradation. Both the UNFCCC and the Rio Declaration echo the principles of Responsibility towards climate change in developed nations. Since 1992, the CBDR principle has been prevalent in climate policy, yet acceptance rates vary. Developed nations argue that countries like China and India exploit CBDR to emit more carbon. However, this contradicts the equity principles of aligning responsibility according to the capacity of a state, suggesting that taxation on developed, developing, and underdeveloped countries should align. The focus should be on equitable burdens and economic principles. This doesn't imply exempting products from third-world countries from taxation but underscores tagging them equitably i.e. having a no one-size-fits-all policy, this would ensure that third-world nations are not disadvantaged by imposing blatant uniformity. Applying such standards establishes a global precedent, reinforcing the equity principle across climate conventions.
The carbon tax proposed by the European Union after the transitional period does not take into account the economic capabilities of countries, as it is uniformly levied based on the quantity of emissions emitted. Countries covered under CBAM are mandated to surrender their CBAM Certificates in proportion to their emitted GHG. This will be a burden on underdeveloped and developing countries. One fundamental tenet of the climate regime, CBDR, has been breached by the aforementioned taxation.
The aforementioned also poses a potential violation of Article 18 of the Vienna Convention on Law of Treaties, which stipulates that a State should refrain from actions that would undermine the objects and purpose of a treaty it has ratified or signed. Hence, any act or step of a State that goes against the principle established under any treaty would have the potential to violate Article 18 of the Convention. The principle of CBDR forms the edifice of the United Nations Framework Convention on Climate Change (UNFCCC). As has been mentioned earlier CBAM poses a potential violation of the CBDR principle and therefore, can be said to be a potential violation of the UNFCCC and subsequently of Article 18 of the Convention.
The countries differ in their economic, social, and political structure due to which the same rate of tax would be unfair. Thus, modulating the rate of tax for some countries may be counterproductive due to the lower ambitions of these countries. So, in order to reflect the CBDR approach, support in the nature of Technology transfer or in the nature of monetary Transactions is required. The uniformly applied CBAM does not align with the CBDR principle. While it includes an objective to assist least developed countries (LDCs), it is expressed in a generic manner and does not adequately consider the differentiated capabilities of individual countries. It discusses financial support solely for the purpose of de-carbonization, particularly in manufacturing industries. However, this focus may not be perceived as fair or helpful in mitigating the fiscal burden imposed by the Carbon tax due to neglect of the emissions from industries other than the manufacturing ones and also due to the absence of any mechanism for support other than the financial support, such as technological support which is considered as essential for de-carbonization.
FREE-RIDING
The CBAM has been enacted, but certain unintended consequences should not be ignored, such as free riding. In this scenario, countries may emit greenhouse gases or carbon in an unregulated manner to minimize costs, enabling themselves to handle the fiscal burden imposed by the European Union through carbon tax. This may manifest in two significant ways. First, due to the high volume of carbon emissions resulting from cost minimization, the impact on climate change will be substantial, defeating the entire purpose of implementing CBAM and both the objectives of the Paris Agreement to limit the increase in the global average temperature to below 2℃ above pre-industrial level and to pursue efforts to mitigate the increase below 1.5℃ will be defeated due to increase in the carbon emission. Thus, resulting in a change in their action plans on climate change known as nationally determined contributions. Secondly, it may lead to market failure, as the final product could end up being more polluting than acceptable, posing vulnerabilities to both communities and climate change mitigation.[1]
The concept of free riding entails a spillover effect, where certain countries enjoy advantages at the cost of others, owing to the global nature of this phenomenon. The absence of an effective legal mechanism for enforcing climate change mitigation agreements, coupled with their voluntary nature, implies that countries will not incur liability for any fiscal burden penalties. This exacerbates the issue, as countries are unlikely to prioritize environmental concerns over their interests, particularly detrimental for LDCs that bear the brunt of the impact of the CBAM.
Free Riding and India
The potential issue of free riding following the implementation of CBAM could negatively impact India's economic growth, given that the South Asia region is already susceptible to the adverse effects of climate change. This poses a challenge as India is actively engaged in climate change mitigation efforts, evident through initiatives like the ‘National Solar Mission’, ‘National Mission for Green India’, and ‘National Water Mission’ etc. The benefits of India's climate change mitigation efforts extend beyond national borders, given the global nature of the environment. However, the economic strain on India's neighbors could act as a catalyst for the free-riding problem if an additional fiscal burden is imposed on their economic growth. This situation poses a risk of a climate disaster and detrimental effects on the development of both India and its neighboring countries. Another issue that could substantially strain international relations is the potential for bilateral problems with neighboring countries arising from climate change concerns such as stresses, tensions, and conflicts on water, food, energy, etc. due to the substantial impact on these resources.
CALCULATION METHODOLOGY AND UNFAIR RESULTS
The ‘implementing regulations’ delineate a methodology for calculating embedded emissions during the transition phase. Subsequently, these embedded emissions would be utilized in determining the import duty applicable to such products. Until the conclusion of 2024, companies will be afforded the option to report in three ways: “(a) comprehensive reporting following the new methodology (EU method); (b) reporting based on an equivalent method (which is universal); and (c) reporting based on default reference values (permissible only until July 2024).”
There remains a challenge in accepting the EU method of reporting, as discrepancies or allegations have been raised regarding the criteria used to set the standards, potentially impacting third-world nations as the production mechanism is not corroborative with the EU standards proving them to incur more cost as compared to other EU products. This raises questions about equality in standards. However, it is premature to pass judgment on these calculations based solely on short-term considerations. In practical experience, it has been observed that the EU has exhibited greater stringency towards imports in its implementation of taxes. What remains to be seen is whether such EU standard calculations will indeed prove to be equitable in nature over the long term. An integral facet of the India-EU Free Trade Agreement is the liberalized import from India; nevertheless, the recurrent issue of disparate standards for non-EU entities persists. In determining the embedded emissions linked to products, fallback default values are set for each exporting country and product category. These values are determined by looking at the average emission intensity of the bottom-performing 10% of installations within each exporting country. If reliable data for a specific country isn't available, default values are based on the average emissions intensity of the bottom-performing 5% of installations within the EU. Moreover, the assessment of embedded emissions related to electricity relies on verified emission data, with default values determined by the emission intensities of the bottom-performing 10% of electricity-generating installations in the third country. Commencing in January 2025, the EU methodology for calculation will be enforced, potentially posing significant challenges for exports from countries such as India. The new regulations, as historically observed, are likely to be rigorous and may not align with existing Indian standards of emission. This could engender substantial difficulties for India.
CBAM - A PROTECTIONIST PERSPECTIVE
The policy also has the potential to adversely affect the interests of non-EU nations, particularly those in the third world where environmental industrialization or viable alternatives to traditional mechanisms may be lacking. While addressing the critical issue of climate change is imperative, providing realistic timelines for achieving the desired objectives is crucial for the equitable implementation of such policies. The transition period, when viewed in real-time, appears highly impractical. For India, a significant trading partner with the European Union, with a trade volume of €88 billion, the challenges become evident. India has raised substantial concerns about non-tariff barriers (NTBs) within the WTO, questioning the move and the associated transition period. The outcome of these discussions remains uncertain. Additionally, there are growing concerns about the foreign policy implications of this move, as Europe appears to be turning more inward-centric, fostering trade protectionism. Some observers also speculate about potential responses from China and Russia, particularly in the context of the Ukraine-Russia war, viewing this policy as a protectionist approach.
THE WAY FORWARD
The Following are the Suggestions that must be incorporated into the CBAM in order to align it with the principle of Common But Differentiated Responsibilities and Respective Capabilities and to address the concerns of India.
One potential initial strategy for tackling the current issue involves implementing a carefully designed taxation mechanism focused on the calculation of direct emissions. In this approach, emission standards would not solely rely on indirect carbon emissions but would also consider the direct and substantial carbon production inherent in the manufacturing process of a product. This adjustment has the potential to significantly alleviate concerns about undue European standardization globally and promote a more equitable framework for setting emission standards.
The tax could be levied on the per-unit share of the site carbon footprint rather than the complete product carbon footprint, as the latter is a complex task and poses potential challenges related to the compromise of trade information. Implementing this approach would effectively address India's concerns about the potential compromise of trade information.
Despite CBAM initially permitting a reduction of the carbon price already paid in the country of origin, the efficacy of these reductions may be jeopardized by the limited global adoption of carbon pricing, creating an inequitable situation globally. Therefore, the EU should reconsider the term "carbon price" and incorporate a reduction in any taxes paid during production related to carbon in the country of origin.
An assessment of the CBDR principle calls for policy adjustments that consider the diverse capacities of nations, ensuring fairness and effectiveness in addressing climate change. Striking a balance between global cooperation and acknowledging differentiated responsibilities is imperative for the success of climate policies. One potential avenue for addressing this issue is by introducing a differentiated standard of treatment for nations in the underdeveloped and developing world, aligning with the CBDR principle. This could involve creating classes or categories with special concessions tailored to the specific needs and capacities of developing and underdeveloped countries. Recognized by WTO members, these classes would be designed ethically, adhering to the CBDR principle, without conflicting with other WTO principles.
It is crucial to ensure that the privacy concerns of Indian manufacturers are addressed effectively. A proper mechanism for the protection of information such as the formation of a dedicated body that will handle all the material resources submitted during the reporting period, should be formulated and implemented. It is essential to prevent any unauthorized access or misuse of sensitive information concerning trade information, and product specifications such as design, and novelty factors.
CBAM may include a provision on the transfer of Climate Technologies as envisaged in the 1992 UNFCCC which talks about the promotion and cooperation in the development and transfer of technologies that reduce emissions of Green House Gasses by the effective use of wind, solar, and hydropower energies. Similarly, the technology mechanism established at COP in 2010 which has two complementary bodies, namely, the Technology Executive Committee and Climate Technology Centre, should be enforced. A network to accelerate and enhance the development and transfer of Climate technologies is needed. Further, an effective implementation of the Joint Work Programme of the Technology Mechanism (2023-2027) should be undertaken with a special focus on the LDCs.
The CBAM should include a conflict-resolving mechanism such as the establishment of a tribunal in order to address the dispute that may arise due to the arbitrary imposition of duties through the way of CBAM certificates, unfair calculations of emissions, etc.
While the carbon tax aims to minimize the risk of environmental damage from carbon industrialization, it poses challenges when viewed through the lens of International Trade Law. There is a need for adjustments in the carbon tax framework to make it more accommodating to other nations. The Indian challenge to CBAM can serve as a catalyst for rectifying deficiencies or anomalies in the current scheme. It opens up an opportunity to refine the carbon tax system to better align with international trade norms and ensure a more inclusive and collaborative approach to addressing environmental concerns.
[1] Ibid.
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