Steel, Taxes and Green Futures: India's MSME Resistance Against EU Carbon Rules

[Aman and Dhruv are students at Rajiv Gandhi National University of Law.]

The much anticipated free trade agreement between India and the EU, which is set to take effect late next year, confronts a number of hurdles. Even though bilateral trade has increased significantly over the previous decade, discussions have stalled due to persistent disputes, particularly in medicines, automobiles, and agriculture. A key point of contention that emerges is the EU's carbon border adjustment mechanism (CBAM), which India has strenuously opposed. The CBAM expands the EU's emissions trading system 2003 (ETS) by imposing a levy on imported items whose production leads to a large amount of carbon emissions, such as steel and aluminum etc. It becomes apparent that India's MSMEs, who are critical players in the export sector, would bear the brunt of this. This blog argues that while CBAM poses a real threat to these MSMEs, India has a strategic way forward: using Article 9 of the CBAM regulations by implementing (smart) domestic carbon pricing and offering targeted support to the businesses. 

Understanding the CBAM Threat

The mechanism and its implications

The primary goal of CBAM, which is now in a transitional period until 2026, is to avoid "carbon leakage," a phenomenon where industries in sectors that generate high amounts of greenhouse gases transfer from countries with stricter environmental restrictions to those with laxer ones. However, several experts have criticized its practical implications, believing because it may unfairly affect developing countries, violating the ‘common but differentiated responsibilities and respective capabilities’ (CBDR-RC) principle and negatively affecting EU's trading partners, particularly the least developed countries, due to the financial burden imposed [see: Magacho et. al. (2022), Rumble & Glider (2024), Venzke & Vidigal (2022)]. We will first explore the impact on Indian MSMEs and then propose solutions.

MSMEs in the crosshairs

For India’s MSMEs, the financial strain is immediate and significant. These businesses are crucial to India’s exports, making up nearly 28% in 2022-23, often in carbon-intensive sectors like metals and fertilizers. They rely heavily on traditional energy sources and are far from maturity in the transition to sustainable alternatives. Consequently, CBAM imposes a financial strain, leaving MSMEs with 3 difficult choices: pay a carbon tax in India and potentially an adjusted amount in the EU, have the Indian government implement a tax to offset the EU's tax, or somehow invest exorbitant amounts in R&D for renewable energy. 

The Article 9 Opportunity

The primary relief emerges in the form of Article 9 of the CBAM regulations. CBAM currently imposes a charge of EUR 80 per metric ton of greenhouse gases (GHG). However, under Article 9(1) of the CBAM regulations, the number of required CBAM certifications can be reduced if a carbon price has already been paid in the country where the goods have originated. 

Current regulatory landscape

Currently, India's clean energy cess stands at INR 400/ton of coal, levied on the fuel itself and  not on the actual carbon emissions it produces. While its purpose was to discourage coal use, there are currently no taxes specifically targeting the amount of GHGs released into the atmosphere [see also: Bhat and Mishra (2019), Barua and Kalita (2024)]. This is crucial as India's coal taxation does not meet the criteria for carbon pricing under Article 9, as the EU's ETS, which CBAM extends, operates on a 'cap-and-trade' system, whereby companies purchase or are allocated permits based on their CO2 emissions which they must surrender enough annually to cover their total emissions, incentivizing a shift towards cleaner energy sources. India's current tax model does not align with this emissions-based, measurable system. 

India has yet to develop its carbon pricing framework to the level seen in the EU, making it difficult to measure against international standards. There is a need to implement a new, direct carbon taxation system. While the Organisation for Economic Co-operation and Development notes that over half of India's GHG emissions are subject to an "effective carbon rate," meaning some cost is indirectly associated with them, India currently does not levy an explicit carbon price. Though scholars have explored various models for a potential Indian carbon market [see: Cariappa & Krishna (2024), Jindal et. al. (2025), Gorain et. al. (2021)], the reality is that a fully operational carbon trading mechanism is not yet in place, and the carbon credit trading scheme is still in its very early stages.

Cost-benefit analysis

MSMEs place significant reliance on coal and petroleum for energy, especially in carbon-intensive sectors like steel, aluminium, and fertilizers, which naturally leads to significant GHG emissions. For MSMEs, the financial strain of directly switching to cleaner energy sources is immense. Further, many lack the technological capacity to accurately measure their emissions, and investing in such technology presents another heavy financial burden.

Examining this through a cost-benefit lens, the situation becomes clearer: if no domestic carbon tax is imposed, Indian exporters would effectively pay the full CBAM charge to the EU. If India implements a full carbon tax at that same rate, that cost is borne domestically, and the CBAM charge is waived, resulting in a net breakeven for the exporter. The most favorable scenario for MSMEs would involve paying this full domestic tax, plus additional incentives to help them transition to greener energy, which would ultimately reduce their tax burden in the long run.

The ideal path for India, then, involves "domesticating" the entire carbon cost. For MSMEs, this means the government imposing a carbon tax equivalent to CBAM's rate. Crucially, any tax lower than this would still result in CBAM being applied to exported goods, and other forms of rebates or compensation wouldn't qualify for exemption under Article 9. Therefore, the most effective strategy is to collect this carbon tax domestically and strategically reinvest those funds directly into supporting MSMEs' transition to cleaner energy resources.

Suggestions

Immediate actions

Suggestions are proposed to domesticate the carbon tax in India. A multifaceted policy strategy is necessary to promote India's vital MSME sector while successfully addressing the problems presented by CBAM. A carefully calibrated carbon pricing mechanism should be put in place by the government, starting with moderate rates and progressively increasing them, to reach the EU's benchmark of EUR 80/ton.  While preserving export competitiveness, this gradual adoption would give MSMEs crucial time for transition.

Moreover, given the significant variations in emission intensities among industries, a differentiated pricing mechanism should be put in place to prevent undue financial hardship. The steel, aluminium, and fertilizer sectors should be given particular emphasis. MSMEs should be given special financial incentives, such as grants, subsidized loans, and tax breaks, to deploy carbon capture technology, energy-efficient equipment, and renewable energy. The money earned by the carbon price should be properly reinvested to support MSMEs.

Structural reforms

To support these actions, the government must set up strong capacity-building programs that use digital tool deployment and training activities to assist MSMEs in accurately measuring and reporting emissions. India should actively promote CBDR-RC principle in ongoing free trade agreements on a global scale, requesting fair transition times and, when appropriate, sector-specific exemptions. 

Domestically, MSMEs would have flexible, affordable compliance choices through emissions trading if India's carbon credit market were operationalized more quickly. Expanded production-linked incentive programs for green technologies and expansion of effective initiatives like Perform, Achieve, Trade to include more MSMEs are examples of further policy support. In addition to reducing the immediate financial impact of CBAM, this all-encompassing strategy would put India's MSME sector in a long-term sustainable position in a world trade climate that is becoming increasingly carbon sensitive.

Conclusion 

The EU's CBAM presents India with a tough but necessary choice: resist and lose competitiveness or adapt and emerge stronger. While critics argue carbon pricing hurts MSMEs, the alternative—paying full CBAM levies—is worse. A phased domestic carbon tax aligned with Article 9 is the smartest solution, allowing India to retain revenue for green investments rather than sending it abroad. The challenge lies in future-proofing India's export economy. The transition, while challenging for the MSMEs, will be a strategic support through tax incentives, green subsidies, and emissions trading can ease the burden. More importantly, delaying action will only increase costs as more countries adopt similar measures. India must view CBAM not as a threat, but as an opportunity to modernize industries and position itself as a sustainable manufacturing hub. The path is clear: implement carbon pricing, reinvest in clean energy, and empower MSMEs to compete in a carbon-conscious world.