By: Khushbu Ahlawat, Consulting Editor, GSDN
A landmark free trade agreement with Brussels has opened Europe’s markets to Indian exporters just as a new carbon levy threatens to close the door again — and how India resolves that contradiction may determine the shape of its industrial decarbonisation for a decade. There is a certain irony in how 2026 has unfolded for India’s trade relationship with Europe. In January, New Delhi and Brussels finally concluded a free trade agreement that had been under negotiation, on and off, for nearly two decades — a deal covering two economies that together account for roughly a quarter of global GDP and close to a third of world trade. It was framed by officials on both sides not merely as a commercial arrangement but as a strategic hedge, a way of anchoring economic ties between two large democracies at a moment when great-power rivalry was reshaping supply chains everywhere. Yet in the very same month that the agreement’s benefits began to take effect, the European Union’s Carbon Border Adjustment Mechanism — better known by its acronym, CBAM — entered its definitive, financially binding phase, adding a new and rising cost to precisely the sectors the FTA was supposed to help. India, in effect, won wider access to the European market and immediately began paying a carbon toll to use it.
That collision between trade liberalisation and climate regulation is not an accident of timing so much as the defining tension of how European climate policy now intersects with developing-country trade. Understanding why CBAM is proving so difficult for India to absorb — and what genuine options exist to turn a costly compliance burden into a driver of industrial modernisation — requires looking closely at both the mechanics of the EU’s carbon levy and the significant gaps in India’s own emerging carbon market.
What CBAM Actually Does, and Why 2026 Is the Year It Started to Bite
CBAM was established under EU Regulation 2023/956, adopted in May 2023 as part of the bloc’s broader “Fit for 55” climate package, with the explicit goal of preventing “carbon leakage” — the risk that European manufacturers, facing rising costs under the EU’s Emissions Trading System, would simply be undercut by imports from countries with laxer climate rules, or would relocate production abroad to escape those costs altogether. For a transitional period running from October 2023 through the end of 2025, CBAM asked only for quarterly emissions reporting from importers, with no actual payment obligation — effectively a dry run to let companies and regulators work out methodology before money changed hands.
That grace period ended on January 1, 2026, when CBAM moved into what the European Commission calls its “definitive regime.” From that date, importers of covered goods — initially iron and steel, aluminium, cement, fertilisers, hydrogen and electricity, alongside certain downstream products like screws and bolts — must be registered as “authorised CBAM declarants” simply to bring those goods into the EU at all; a March 31, 2026 deadline for that authorisation has already passed, and shipments from unregistered importers now risk being blocked at customs entirely. Each year, declarants must purchase and surrender CBAM certificates corresponding to the embedded emissions in their imports, priced against the weekly average auction price of the EU’s own Emissions Trading System — a price that stood at roughly EUR 75 per tonne of CO2 equivalent as of March 2026 and had climbed further, to around EUR 75.28 (about US$87), by the second quarter of the year. Notably, the definitive regime treats sectors differently: for iron, steel and aluminium, only direct production emissions count toward the certificate obligation for now, while cement and fertiliser imports must additionally account for indirect emissions embedded in the electricity used to produce them — a distinction that matters because it foreshadows exactly the kind of expanded, harder-to-avoid liability India’s exporters are likely to face as the mechanism’s scope widens in future years. Free allowances that currently cushion EU domestic producers under the ETS are themselves scheduled to be phased out gradually between 2026 and 2034, meaning the certificate cost that CBAM imposes on importers is set to climb in tandem, not remain static.
For India, the exposure is concentrated and severe. India’s CBAM-affected exports to the EU were valued at roughly US6.4billionin2023,themostrecentyearforwhichconsistentdataexists,withironandsteelalonecontributingtheoverwhelmingmajority—someUS5.41 billion — followed by aluminium at US$0.97 billion and much smaller contributions from cement and fertilisers. The steel sector’s exposure is compounded by a structural disadvantage: Indian steel production carries a direct emissions intensity of roughly 4.68 tonnes of CO2 equivalent per tonne of output, close to double the EU27 average of 2.3 tonnes for a comparable product mix — meaning Indian steel doesn’t just face CBAM’s cost, it faces a disproportionately high version of it compared to competitors with cleaner production processes. The early data bears this out starkly: by April 2026, just months into the definitive regime, India’s iron and steel exports to the EU had already declined by 13 percent since the start of the year. That is a meaningful contraction in a relationship where the EU ranks as India’s third-largest trading partner, with bilateral goods trade worth roughly EUR 118 billion in 2025, representing about 11.1 percent of India’s total trade.
Why India’s Own Carbon Market Can’t Simply Absorb the Hit
The obvious question is whether India’s own domestic carbon-pricing system can offset this exposure — after all, CBAM’s founding logic explicitly allows importers to deduct any carbon price already paid in the country of origin, precisely so that exporters aren’t taxed twice for the same emissions. India does have such a system: the Carbon Credit Trading Scheme, established through a 2022 amendment to the Energy Conservation Act, 2001, which serves the dual purpose of giving India’s carbon market a legal foundation and helping the country meet the emissions-reduction targets it has pledged under the Paris Agreement’s Nationally Determined Contributions framework.
The trouble is that the CCTS and CBAM were built on fundamentally incompatible architectures. CBAM prices a fixed cost per tonne of embedded emissions in every covered import. The CCTS, by contrast, is an intensity-based baseline-and-credit system: firms that outperform their assigned emissions targets earn tradeable credits, while those that fall short face a financial penalty rather than a straightforward carbon price. That structural mismatch alone makes it difficult for compliance under one system to translate cleanly into recognised credit under the other. Making matters harder, the CCTS is not currently recognised under Article 9 of the CBAM regulation — the specific provision that lets EU importers reduce their certificate obligations by deducting a verified carbon price already paid at origin. India did secure what has been described as a “forward-looking most-favoured-nation assurance” as part of the FTA negotiations, guaranteeing that India won’t be treated worse than other trading partners as CBAM implementation evolves — but that is a non-discrimination guarantee, not formal recognition of the CCTS as an equivalent carbon-pricing mechanism.
Even in the best case, where the EU eventually agreed to recognise verified CCTS costs, the financial relief would be modest at best. CCTS credit prices are currently estimated in the range of US11toUS15 per tonne — against a CBAM certificate price approaching US$87 per tonne in mid-2026. That is roughly a sixfold gap, and it is not a gap that incremental price convergence closes quickly. Layered on top of this pricing mismatch is a further complication specific to India’s electricity grid: because India’s power generation still leans heavily on coal and grid emissions intensity varies substantially by state, exporters in different parts of the country will face materially different CBAM costs depending on where their production is located — a regional cost variation the CCTS, focused on sector-wide baselines, was never designed to capture.
From Defensive Compliance to Strategic Leverage
None of this means CBAM is destined to permanently erode India’s competitiveness in Europe. Industry analysis — including a 2025 report from Ernst & Young — has argued that the mechanism can be treated as a prompt for revenue-enhancing diversification rather than purely a defensive cost to be absorbed. One pathway is geographic: shifting export volumes away from the EU and toward non-CBAM markets in Africa, Latin America and the Middle East, several of which already offer higher unit revenues for Indian steel and aluminium than the European market does, potentially generating enough additional margin to help cover the cost of whatever CBAM certificates remain necessary for the EU-bound share of exports.
A second, more structural pathway involves treating CBAM as leverage for genuine industrial decarbonisation rather than merely a compliance cost to be minimised. Strengthening the CCTS itself is the obvious starting point — deepening market liquidity, tightening baseline stringency, and building more rigorous monitoring, reporting and verification systems, all of which would help establish a credible, defensible domestic carbon price that the EU might eventually be persuaded to recognise under Article 9. Alongside this, transition finance instruments — carbon-linked green bonds targeted specifically at CBAM-exposed sectors like steel, aluminium, cement and fertilisers — could help absorb the up-front cost of abatement technology, with repayment terms structured to reward measurable emissions cuts, which would in turn reduce both future CCTS compliance costs and CBAM liabilities in a mutually reinforcing cycle.
There is also a case for direct India-EU cooperation on financing the transition, rather than leaving Indian exporters to bear the adjustment cost alone. One proposal gaining attention among trade-policy researchers is an India CBAM Levy Industrial Decarbonisation Fund, under which India would collect a domestic levy on CBAM-covered exports and channel the proceeds directly into industrial decarbonisation projects, with Brussels formally recognising this effort under Article 9 in return — potentially structured with matching EU contributions and a shared governance role in setting the fund’s priorities. A two-year pilot of such an arrangement could plausibly be built around the EUR 500 million in new climate finance the EU has already committed to India, giving both sides a low-stakes way to test whether a jointly governed fund can actually bridge the recognition gap that the CCTS alone cannot close. Any such arrangement would also need a specific carve-out for small and medium enterprises, which are disproportionately exposed to CBAM’s compliance demands given their limited capacity to handle emissions verification and standardisation procedures relative to larger, better-resourced exporters.
Conclusion: A Test Case for Climate Justice in Trade Policy
CBAM sits at an uncomfortable intersection of legitimate climate ambition and a longer, unresolved history of inequity in how the costs of decarbonisation get distributed between the industrialised world and developing economies. The EU’s framing of the mechanism — as a tool to prevent carbon leakage and reward cleaner production — is defensible on its own terms, but it also shifts a meaningful share of the transition’s financial burden onto exporters in countries like India that industrialised later, on dirtier grids, and with far less accumulated capital to fund a rapid clean-technology upgrade. For India, the practical response cannot be a single lever pulled once. It will require a genuinely parallel effort: strengthening the CCTS until it is robust enough to earn EU recognition, using targeted transition finance to accelerate real emissions reductions in the most exposed sectors, diversifying export markets to reduce dependence on CBAM-covered trade routes, and — perhaps most importantly — persuading Brussels that a jointly governed decarbonisation fund serves both sides’ interests better than a one-way compliance regime does. Handled well, CBAM could become the forcing mechanism that finally accelerates India’s industrial decarbonisation on India’s own terms. Handled poorly, it risks becoming simply another cost of doing business with Europe — one that falls hardest on the small and mid-sized exporters least equipped to pay it.
