Europe’s India Strategy Cannot End at the Border: The CBAM Trade-Off

As multilateral efforts to liberalize trade have been increasingly failing, the European Union (EU) endeavours to identify strategic bilateral partnerships. A key example is the EU-India Free Trade Agreement (FTA) negotiations, described as the ‘mother of all deals’ by EU Commission President Ursula von der Leyen.

Yet, while Brussels and New Delhi are attempting to dismantle barriers to trade, the Carbon Border Adjustment Mechanism (CBAM) is introducing a new layer of carbon-conditioned market access. This raises a key question: can Europe’s climate ambitions and industrial strategy evolve together?

India as an Ally

The EU’s renewed interest in India is not accidental. COVID-19 pandemic, geopolitical tensions, trade wars and excessive dependence on China fundamentally altered European perspectives about economic security.

India occupies a significant role in catering to European interests. A major manufacturing hub, it possesses a rapidly expanding domestic market, an increasing capacity for renewable energy, competitive manufacturing costs, and substantial industrial scale.

The EU-India FTA should therefore be understood as an industrial partnership designed to support resilient and diversified value chains in a post-China-dominant world, rather than a simple trade agreement.

CBAM Risks Crowding Out the ‘Mother of All Deals’

This strategic ambition, however, now intersects with decarbonisation, a pillar of European policy. The Carbon Border Adjustment Mechanism (CBAM) has extended the logic of the EU Emissions Trading System (ETS) beyond European borders. Importers of products such as steel, aluminium, cement and fertilisers are required to purchase carbon certificates linked to European carbon prices.

The mechanism seeks to prevent carbon leakage. However, the key sectors to the EU-India partnership are among the ones most heavily exposed to CBAM-related costs. As a result, tariffs removed under the FTA may effectively be offset by carbon-related compliance costs.

For many exporters, the ability to measure, verify and report emissions according to European standards is a major challenge too. Competitiveness thus depends not only on production efficiency, but also on carbon-governance capacity.

Moreover, not every exporter will be symmetrically impacted by CBAM. In fact, the provision does not apply to Countries with similar carbon pricing schemes to the ETS. This could be interpreted as an appreciation of foreign efforts to curb emissions but could potentially conflict with WTO Law. In fact, the EU is bound to comply with the non-discrimination principle, mandating that WTO Members shall not discriminate between like-products imported from different Members.

However, Article XX(g) and XX(b) GATT could offer a legal basis to argue for CBAM’s legality, as they allow to forego GATT obligations to protect exhaustible natural resources and human, animal or plant life respectively. Ultimately, CBAM’s admissibility under WTO Law will likely depend on its implementation and should be evaluated on a case-by-case basis.

Nonetheless, this clearly highlights how CBAM poses a multi-faceted challenge for the EU. The Union will have to ensure the regulation’s compatibility with the economic liberalization sought by the India-EU FTA while guaranteeing its compliance with WTO law.

India Is No Longer Only Contesting CBAM

India’s response to CBAM has historically been largely defensive. However, legal contestation is evolving towards domestic transition governance.

The Carbon Credit Trading Scheme (CCTS), introduced under India’s Energy Conservation (Amendment) Act 2022, represents the country’s first serious attempt to establish a domestic carbon-pricing architecture. The CCTS could offer Indian exporters a path to compliance with EU requirements.

However, unlike the EU-ETS, which operates through an absolute emissions-cap framework, the Indian system relies on emissions-intensity targets across major industrial sectors. The compatibility of an intensity-based system with a cap-based one remains rather unlikely.

In fact, in order to be exempted from complying with CBAM, trade partners are required to either:-

A. Be subject to the EU ETS or sign an agreement to fully link their national emission trading system to it; 

B. Charge on greenhouse gas emissions embedded in domestic goods a carbon price without any rebates beyond those also applied in accordance with the EU ETS.

These are extremely rigid and demanding requirements. Unsurprisingly then, only four countries amongst the closest partners of the EU currently benefit from this exception.

The strategic significance of this issue is clear. The future of EU-India climate-trade cooperation increasingly depends on the compatibility of their climate governance frameworks.

Green Industrial Cooperation: Opportunities and Challenges

Discussions over tariffs and carbon costs risk overshadowing the key opportunity of the EU-India relationship, the construction of complementary green industrial value chains.

India possesses significant advantages in renewable-energy integration, industrial scale and labour-intensive upstream manufacturing. Europe retains comparative advantages in high-end engineering, industrial innovation, green finance and high-value downstream manufacturing. Hence, complementarities between the two economies do exist.

However, green industrial partnerships are contingent upon a series of key technologies and production inputs. As an example, green hydrogen requires critical resources, including water. Because water scarcity is a key developmental challenge in India, any viable partnership in this sector – and in similar ones – would require technological collaboration to address these resource constraints.

Concerns could also arise from value-chain structure. A successful partnership must allow both sides to move up the value ladder rather than compartmentalizing advanced manufacturing in Europe and carbon-intensive production in India.

Furthermore, Monitoring, Reporting and Verification (MRV) systems remain underdeveloped particularly among smaller firms, which may particularly struggle to meet CBAM requirements.

Nonetheless, the EU has already structured bilateral frameworks – such as Green Alliances and Green Partnerships – to address these concerns. The former bind both parties to achieve carbon neutrality and align their climate policies. The latter are specialized bilateral or regional agreements addressing specific climate-related needs of the EU’s partners.

Within both frameworks the EU has agreed to industrial partnerships and low-carbon technology diffusion, supporting its counterparts’ efforts towards sustainable development.

As such, Green Partnerships could constitute an effective model to assist Indian producers in complying with CBAM, provided that the legal framework for low-carbon technology diffusion is clearly defined.

Can CBAM Revenue Become Transition Finance?

Another possibility suggested to facilitate compliance with CBAM would be to recycle a portion of its revenues to support non-EU producers’ green transition. However, the idea remains controversial.

An automatic distribution mechanism, directing border adjustment revenues to third-parties, would be unprecedented in EU history. Traditionally, the Union has financed sustainable development frameworks, such as Green Partnerships, via its central budget.

Currently, CBAM is no exception. Nonetheless, this does not imply that CBAM revenues could not support India’s sustainable development. They could indirectly do so, via an investment project or a Green Partnership financed by the EU budget.

Ultimately, the dispute on CBAM revenues is a framing issue. Earmarking them would contrast the public perception of CBAM as a purely defensive mechanism. However, already established cooperation frameworks could offer a clearer path for cooperation.

Conclusion

The EU faces a trade-off between seeking India as a strategic industrial ally while upholding its environmental market-access conditions.

The challenge is therefore not simply to make CBAM legally defensible within the multilateral trading system, but also compatible with the very partnerships Europe seeks.

If the EU-India relationship is to evolve into a genuine green industrial alliance, climate governance must become part of a shared transition strategy rather than a new architecture of conditional trade integration.

This article is written by:-

Mr. Suvajit Banerjee

Fellow at the National Council of Applied Economic Research 

(NCAER), New Delhi. 

Mr. Tommaso Morotti

Dual degree graduate student, pursuing a Master’s in Economics and Management of International Organizations from Bocconi University and an MPA from Rockefeller College of Public Affairs and Policy. 

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The views and opinions expressed in this article are those of the contributors and do not necessarily reflect the official policy, position, or editorial stance of EIJ. EIJ provides a platform for diverse perspectives and informed debate. Responsibility for the accuracy of facts and interpretations rests solely with the authors.