It may be premature for India to mandate emissions trading

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By Rajnish Gupta

Both the budget and the Economic Survey were silent on the introduction of the mandatory Emissions Trading Scheme, though energy transition is high on the government's agenda.

The new administration in the US has withdrawn from the Paris Agreement. "Drill, baby, drill" reflects the intent to make cheap energy available for businesses. Growing manufacturing and creating jobs are the focus of the US government.

For India, too, accelerating private investments, growing manufacturing, and job creation are high on the economic agenda. In addition, energy transition and mitigating the impact of climate change continue to be important. The focus is on competitive, low-cost, round-the-clock green energy that minimises import dependence.

Budget announcements about nuclear energy, renewables, the development of transmission capacity, and distribution sector reforms reflect the intent. The manufacture of clean-tech products is also high on the government's agenda, as a competitive domestic supply chain is imperative for a successful energy transition.

A mandatory Emissions Trading Scheme (ETS) is in the pipeline

One measure discussed extensively in the past, though not mentioned in the current budget, is the introduction of a mandatory ETS. The question now is how will the proposed ETS impact India’s manufacturing competitiveness?

Europe's experience with a high carbon price is instructive. Despite having one of the highest carbon prices in the world, real gross value added (GVA) from manufacturing in 2023 was lower than in 2018. A recent report on the competitiveness of the EU acknowledges that ETS adds to manufacturing costs, especially for energy-intensive industries. As free allowances are withdrawn, its impact would be even greater. A Carbon Border Adjustment Mechanism is being proposed to countervail the increase in production costs due to ETS.

India’s manufacturing competition with East Asia

India is seeking to become a part of global supply chains. While China continues to be the largest merchandise exporter with a trillion-dollar surplus, there have been some changes in supply chains. In addition to India, manufacturing capacities have emerged in countries like Mexico, Vietnam, and other ASEAN countries. Furthermore, India has a comprehensive FTA with ASEAN. It would be prudent to assume that manufacturing in India will need to be competitive, especially in comparison to China and ASEAN countries.

ASEAN and China do not impose a high carbon price on manufacturing, though there are proposals and discussions underway. Most states in the US do not have a mandatory emissions trading system. A significant carbon price on domestic manufacturing in India would add to both the cost of manufacturing and compliance.

If a mandatory carbon price through an ETS were to be implemented in India, there may be a need for a CBAM-type levy by India to countervail imports from countries that either do not impose a carbon price on their domestic manufacturing or impose a lower carbon price than would be discovered in India.

As it is, India does not have a duty that countervails duties and taxes outside the GST. Remission of Duties and Taxes on Exported Products (RoDTEP) rates may also need revision so that Indian exporters are reimbursed the carbon prices paid for manufacturing in India when exporting to countries where there is no carbon price.

Emissions are a global externality, and climate mitigation requires global consensus. Given recent developments, a consensus on the short term is difficult to envisage.

It may be noted that even without an ETS, India is on track to meet its 2030 commitments under the Paris Agreement, i.e., the development of 500 GW of non-fossil fuel capacity and reducing the carbon intensity of its economy by 45 percent from its 2005 levels.

Given the concerns, it might be helpful to revisit the timing for India’s introduction of a mandatory ETS. The carbon credit trading scheme for voluntary players can always continue. A more pragmatic approach would be to ensure easy availability of competitively priced green power to Indian manufacturers, which is proposed to be done through the development of nuclear energy, renewables, and energy storage solutions. The paradigm can be revisited as the share of manufacturing in the Indian economy grows, and the dust settles down on the tariff changes currently underway.

(Rajnish Gupta is Partner, Tax and Economic Policy Group, EY India.)

Views are personal, and do not represent the stance of this publication.