India needs to balance conflicting interests as it designs an emission trading system

EU's ETS operations for the last two decades will throw some light on putting together a suitable set of policies.

China implemented its own Emission Trading System (ETS) in 2021 to meet its commitment to climate change mitigation efforts. Despite limited participation from the power sector players, it has quietly grown into the world’s largest ETS in volumetric terms. Indonesia launched a national ETS this February with limited power sector participation. While India also announced a cap-and-trade ETS for the power sector, it is time to look around in terms of the design of an efficient ETS with participation from businesses beyond the power sector, which account for 60 percent of the national emissions. Operations of the ETS for the last two decades in the EU will throw some light on putting together a suitable set of policies, both in market design and in regulating market fundamentals in terms of demand and supply of Emission Reduction Credits (ERCs).

Design Constraints

India will face several design constraints in implementing an efficient ETS. These constraints are unique to India’s political, economic, and social contexts. They must be identified and addressed for an ETS to deliver on its objective of transparently and cost-effectively reducing emissions while promoting economic growth. An analysis of historical data proves that emissions and economic growth are strongly positively correlated. It necessitates policymakers’ access to a robust database to have a fair view of the economic impact of caps for any economic sector as the market expands beyond the power sector. As an ETS is all about fixing a cap for emitters and creating a market for the ERCs, the right level of compensation at the right time for the emissions credits will help the market serve its intended objectives. While the market will price ERCs per their supply and demand, as the policy determines the caps and issuance of credits, caps would have to be fine-tuned from time to time based on robust data.

India has a diverse economy, with a wide range of industries, each with different emissions levels. This creates challenges in designing a fair and equitable system. Taking a cue from the EU ETS, which issued allowances to emitters with a cap in line with the significance of the economic impact on a given sector, it could avoid potential ‘carbon leakage,’ i.e., industries crossing borders creating socio-economic problems. Indian industries, particularly those in energy-intensive sectors, may face competition from industries in countries that do not have similar carbon pricing mechanisms. This could lead to concerns around competitiveness and may discourage companies from participating in the ETS.

Challenges To Consensus

Socially, politically and culturally, India is like the European Union, with different states having different priorities and concerns. Achieving consensus on a national ETS could be challenging, and there may be resistance from some sectors with players citing equity and potential unemployment scenarios. Further, implementing an ETS may have socio-economic implications, particularly for the vulnerable/marginalised. There would always remain the risk that the cost of emissions allowances could be passed on to consumers, leading to higher prices of goods and services, including energy.

Implementing a national ETS will require significant investment in capacity and infrastructure, including developing measurement, reporting, and verification (MRV) systems. Considering the same, enabling the establishment of private trading platforms backed by a robust and independent national regulatory authority will go a long way in empowering capacity development in terms of MRV systems. India must carefully design and implement an ETS tailored to its unique context. This will require strong political will and investment in capacity building and infrastructure. India may also need to explore alternative policy tools, such as subsidies and tax incentives, without impairing the ‘additionality’ concept in supporting the transition to a low-carbon economy. It will be essential to engage with stakeholders from all sectors of society to ensure that the design of the national ETS is fair, equitable and effective.

As is Climate Change, its mitigation would also have to be empowered through the global sharing of resources between developed and developing countries to make it a win-win for the stakeholders. Markets can only be the best mechanism for enabling such economic transactions. Hence, there is a greater need for globally harmonised rules and regulations enabling resource and technology transfer, making mitigation a seamless affair. Harmonised rules and regulations of different ETS will be the first step in the process if we take a leaf out of the Kyoto Protocol and the functioning of the United Nations Framework Convention on Climate Change (UNFCCC). This will ensure consistency in measuring, verifying, and trading emissions across different markets. International standards for MRV on the earlier lines would be the best foot forward. Mutual recognition can further be achieved through bilateral/ multilateral agreements between different ETS in the absence of harmonisation of regimes. A global ETS integrating national ETSs will be the best way forward to make climate change mitigation an economically less painful affair. There can’t be an appropriate forum than G20 under India’s leadership to discuss, debate, and take it to an appropriate forum for global consensus.

V Shunmugam is Adjunct Faculty at National Institute of Securities Markets. Views are personal, and do not represent the stand of this publication.