International Trade Has a Carbon Problem

Why in News?

• India is concerned about European Union's new climate law Carbon Border Adjustment Mechanism (CBAM).
• This new law could disrupt international trade, has potential to impact India-EU trade, and could affect LMICs (Lower Middle-Income Countries) and Developing Countries.

 

EU's Climate Change Policy (ETS), Concern and CBAM

• Emissions Trading System (ETS): Adopted in 2005, the ETS is a market-based mechanism that aims at reducing greenhouse gas (GHG) emissions by allowing bodies emitting GHG to buy and sell these emissions amongst themselves.
• EU’s Concerns Regarding ETS
  • While it has a mechanism for its domestic industries, emissions embedded in products imported from other countries may not be priced in a similar way due to a lack of stringent policies in those countries.
  • This would put its industries at a disadvantage. To tackle this, the impacted industries in the EU had so far been receiving free allowances or permits under the ETS.
  • Furthermore, the EU also apprehends the phenomenon of ‘carbon leakage’ - European firms operating in carbon-intensive sectors might shift to those countries that have less stringent GHG emission norms.
• Formulation of CBAM (Carbon Border Adjustment Mechanism)
  • CBAM is aimed at addressing above concerns, and, therefore, levelling the playing field for the EU industries.
  • Under the CBAM, imports of certain carbon-intensive products, namely cement, iron and steel, electricity, fertilisers, aluminium, and hydrogen, will have to bear the same economic costs borne by EU producers under the ETS.
  • The price to be paid will be linked to the weekly average of the emissions priced under the ETS.
  • However, where a carbon price has been explicitly paid for the imported products in their country of origin, a reduction can be claimed.

 

Issues with CBAM

• Discriminatory Law
  • The CBAM only considers ‘explicit’ carbon prices, not ‘implicit’ costs (non-price-based costs) borne by products originating in certain countries.
  • Accordingly, it arbitrarily or unjustifiably discriminates between countries where the same environmental conditions exist.
• Impact on Developing Countries: Without adequate assistance for newer technologies and finance, it would amount to levying taxes on developing countries.

 

India's Concern about CBAM

• Protectionist and Discriminatory
  • India fears that CBAM will affect the export of its carbon-intensive products to the EU.
  • While India’s exports may be limited to aluminium, iron, and steel, and affect only 1.8% of its total exports to the EU, India has reportedly decried CBAM as being protectionist and discriminatory.
• Unfair Advantage to EU companies over India Companies: CBAM could give an unfair advantage to EU domestic industries at the expense of Indian exporters.

 

Impact on India-EU Trade

• Demand Could Shrink: The EU accounts for 11.1% of India’s total global trade. This new climate law has the potential to make Indian goods less attractive for buyers and could shrink demand.
• New Challenges for Companies: CBAM cause new challenges for companies with a large GHG footprints as they will have to incorporate new machinery and technology which will become an immediate challenge.

 

The Possibility of Challenging CBAM at the WTO (World Trade Organisation)

• There is already talk of challenging the CBAM at the WTO’s dispute settlement body.
• The debate brings to the forefront the inter-linkages between trade and the environment.
• While the international trade regime allows countries to adopt unilateral measures for safeguarding the environment, environmental protection should not become a smokescreen for trade protectionism.
• The CBAM needs to be viewed from this standpoint and, therefore, most likely will be challenged.

 

Does CBAM violate WTO rules?

• Whether the CBAM complies with WTO rules falls on two primary tests that it is -non-preferential and reciprocal.
• The foundational doctrine of the WTO, included in the most-favoured nation (MFN) language contained in Article I of the General Agreement on Tariffs and Trade (GATT), is that a concession made to one must be made to all. This prohibits discrimination among countries.
• Also,GATT Art IIIrequires that any internal rules cannot provide preferential treatment to domestic goods or production over imported products.
• The CBAM could therefore encounter difficulties by treating foreign-produced goods differently and by affording protection for domestic industry by subjecting foreign products to an import tariff.

 

Challenges Before WTO Panel

• Finding the Relevance of PPMs w.r.t CBAM
  • On the application of process and production methods (PPMs), the WTO has failed to take a sharp policy line.
  • It is thus possible that various applications of the CBAM could be individually litigated.
  • For example, a country could bring a complaint against the CBAM as a package or alternatively bring a complaint against the calculation methods used to assess the carbon content of a single commodity, such as steel.
• Possibility of Case-by-Case Judgement in CBAM: For example, given that electric arc furnaces and blast furnaces are two extremely different types of technology, it might be simpler to decide that two products are not "like" in the case of steel.

 

EU’s Arguments in CBAM’s Defence

• The application of the CBAM is not inherently extraterritorial because it applies only to imports into the EU, even if it is aimed at encouraging higher environmental standards in third countries.
• The tax paid by the importer will be equivalent to the cost of allowances EU producers will be forced to pay, such that the CBAM is not inherently discriminatory.
• The EU could justify CBAM by invoking the General Exceptions clause given in Article XX of the GATT. Under Article XX, measures taken by countries are permitted -
  • If they fall under one of the listed policy grounds (‘conservation of exhaustible natural resources’).CBAM would fall under this category.
  • If they satisfy the requirements of the introductory clause of Article XX, which requires that countries do not apply measures in a manner that results in arbitrary or unjustifiable discrimination.

 

Conclusion

• CBAM is also an important issue in the ongoing India-EU free trade agreement
• India should work with the EU to secure gains on CBAM and ensure smooth on boarding for Indian exporters to maximise the benefits of a bilateral deal.

 

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Q1) What is an FTA (Free Trade Agreement)?

Free Trade Agreement (FTA) is an agreement between two or more countries where the countries agree on certain obligations that affect trade in goods and services, and protections for investors and intellectual property rights, among other topics.

 

Q2) Which emissions have to be reported under CBAM?

Three greenhouse gases must be reported under CBAM; Carbon dioxide (CO2), nitrous oxide (N2O) and perfluorocarbons (PFCs). Both direct and indirect emissions of these greenhouse gases for the listed goods in Annex I and only direct emissions of these greenhouse gases for the listed goods in Annex IA must be reported.

 

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Source: The Hindu