India-EU FTA: Why carbon tax poses a major challenge as a non-tariff barrier

Despite the optimism expressed as late as last month (November '25) at the
conclusion of the 11th India-European Union (EU) Foreign Policy and Security Consultations, that the long-drawn negotiations on the Free Trade Agreement (FTA) would be concluded by the end of this year, it is obvious that it will spill over to next year.

In fact, Commerce & Industry Minister Piyush Goyal has gone on record to state that the next round of talks is scheduled in early January 2026. India is the fourth largest economy; EU the second largest. There is a lot of synergy, and it makes eminent economic logic for these two powerhouses to conclude an FTA— so even as the talks (which started in 2007, stalled in 2014 and recommenced in 2021) are chugging along towards the finish line, the issue of Carbon Border Adjusted Mechanism (CBAM) looms large.

It may be recalled that EU had introduced the concept of ‘European Green Deal’ in 2019 to achieve carbon neutrality by 2050. CBAM was thereafter introduced as a legislative proposal in 2021. Since 2003 obligations were increased mandating the reporting of the quantity of imported goods, their embedded carbon emissions and costs incurred in the exporting country. The second phase will kick in from January 1, 2026 – where a financial burden is to be imposed.

CBAM seeks to ensure that goods imported into the EU bear the

same carbon emission cost as goods manufactured within EU; it in effect seeks to promote ‘cleaner’ production in the countries seeking to export to EU. CBAM is to be imposed on carbon-intensive products like iron & steel, electricity, aluminum, cement, fertilisers, and hydrogen imported to the EU. Beginning 2026, a carbon tax (CBAM) will be collected on each consignment of steel imported into EU.

Though CBAM is disguised as being for the larger good of humanity by imposing conditions on exporting countries, it is a moot point whether the proposed CBAM is WTO compliant. It most certainly is a non-tariff barrier and undermines an FTA. Forgotten is the fact as has been pointed out, that a lot of the ‘emission transfer’ from developed countries to developing countries began because of global outsourcing to take advantage of cheaper
labour and relaxed environmental norms.

All these directly benefited the developed countries which now adopt a ’sanctimonious approach’. Forgotten also is the commitment given by
developed countries including EU under the Paris Accord of supporting the green transition of developing countries. Arguably thus CBAM is not in keeping with the principles of Common but Differentiated Responsibilities and Respective Capabilities (CBDRRC) of the WTO. India has opposed the CBAM in the WTO in the backdrop of India’s commitment to the Paris Accord
and its aim to achieve carbon neutrality by 2070.

CBAM will impact India’s exports. India had produced 152 million MT of steel in 2024 and is the world's second largest producer of steel. EU is the major market for iron, steel and aluminum; around 38% (US$ 3.7 billion) of our steel and 27% (US$ 2.7 billion) of our aluminum are exported to EU. It is estimated that annually about US$ 8 billion worth of goods falling under CBAM are exported from India to EU. The impact could be higher given our dependence on generation of coal-fired electricity. India has a carbon-pricing regime-but at
US$ 1.6 per tonne of CO2 emission it is about the lowest globally. The change over to other forms of energy will take time and money.

CBAM will be accompanied by the phasing out of EU’s Emission Trading System (ETS) the equivalent of CCTS. The effect of CBAM and their phasing out will also add to costs to EU imports — and impact Indian exports. Even though CBAM’s compliance with WTO requirements is dodgy, CBAM will be a reality come 2026 — and we must learn to deal with it. This is more so since US also an important market, has imposed a 50% tariff and there is news that Mexico is also going to follow suit.

It may be recalled that India has since 2023 introduced a Carbon Credit Trading Scheme (CCTS) — a ‘permit’ which sets mandatory limits of emission of CO2 or other greenhouse gases. Such limits have been set for 253 steel units covering most steel production in the country. Thus, in effect CCTS seek to incentivise companies which emit lesser than the cap fixed by permitting the carbon credits left to be traded to companies which have exceeded
the cap. The scheme encourages innovation, rewards ‘green’ companies, penalises the defaulters and enables companies to make the costly but essential transition to more energy compliant and efficient sources. CCTS also enable companies to comply with SEBI’s mandate regarding ESG.

We would need to ensure that CCTS is implemented vigorously. It is important that the scheme is seen as credible. As a report of the London School of Economics (LSE) shows the caps fixed are not high or ambitious enough. Thus, a large steel producer needs to make only a 2% annual emissions reduction— this is not penalty or incentive enough to make the necessary technological changes. The targets need to be increased to incentivise rapid change
so essential if we are to achieve decarbonisation.

The Secretary (Ministry of Steel) at a recent conference while acknowledging the impact of CBAM has highlighted government’s plans to decarbonise the steel industry. As per him in the short-term, India aims to reduce emission intensity from 2.5 mt of CO2 per mt of steel to 2.2 through adoption of efficiency improvements. Hydrogen as an option is being increasingly explored rather than the electric arc furnace route. Simultaneously, India needs
to expand its export basket— an analysis shows that flat-rolled products are the major component of steel exports and that too primarily to only 5 EU countries. Given India’s steel manufacturing strength and the world’s requirements for steel, markets in Africa and in the Gulf need to be explored.

We would also need to explore the possibility as suggested in some
quarters of a retaliatory tariff on EU products — but be cognizant that this Trumpian approach will also hurt our importers. The sooner all these measures are put in place the better. In the meantime, our exporters should brace themselves to face the challenges.

—The author, Najib Shah is former chairman, Central Board of Indirect Taxes & Customs. The views are personal.