A delicate deal: India–UK FTA finalized amid carbon tax frictions

On May 6, 2025, India and the UK signed a long-anticipated Free Trade Agreement after more than three years of negotiations, amid unresolved tensions over the UK’s Carbon Border Adjustment Mechanism (CBAM), due in 2027.

While India did not secure an exemption, it negotiated a “rebalancing mechanism” allowing it to seek compensation for trade losses caused by CBAM.

Image Source: Pixabay

On May 6, 2025, India and the United Kingdom signed a long-awaited Free Trade Agreement (FTA), concluding over three years of intense negotiations. A key point of contention was the UK’s proposed Carbon Border Adjustment Mechanism (CBAM)—a carbon tax on imports of goods with high emissions footprints.

The UK’s draft CBAM legislation- set to take effect from January 1, 2027– will impose a carbon levy on imported products such as aluminium, cement, fertilisers, hydrogen, iron, and steel. These sectors are considered carbon-intensive and thus subject to climate-related trade regulation.

India’s proposed ‘Rebalancing mechanism’

India, opposing the absence of concessions in the UK’s CBAM, proposed a “rebalancing mechanism“. This clause would allow India to seek compensation for any economic losses its industries suffer due to CBAM. It also protects India from potential trade disputes under the World Trade Organization (WTO) framework.

Key Provisions of the Rebalancing Mechanism;

1. The mechanism is included in the General Exceptions chapter of the FTA text, which mirrors the WTO’s General Agreement on Tariffs and Trade (GATT) rules.
2. These exceptions permit measures that might otherwise breach trade rules, as long as they are justified- for instance, for environmental protection or public health.

About Carbon Border Adjustment Mechanism (CBAM)

Introduced by the European Union in 2021, the Carbon Border Adjustment Mechanism (CBAM), or carbon tax, targets imports based on the carbon emissions produced during their manufacturing. For example, steel imported from countries with higher emission levels than those permitted under EU standards would incur a tax upon entry.

According to the World Bank, a carbon tax sets a price on carbon either by defining a tax rate on greenhouse gas (GHG) emissions or on the carbon content of fossil fuels. CBAM is a form of carbon pricing, along with emissions trading systems (ETS).

The CBAM enables European industries to stay competitive without compromising on their high environmental standards. In doing so, it seeks to promote a reduction in global carbon emissions.

It aims to:

• Maintain high climate standards in Europe.
• Prevent carbon leakage—the shift of production to countries with less stringent environmental norms.
• Level the playing field between domestic and foreign producers.

However, CBAM negatively impacts the export competitiveness of developing countries. 

Impact on developing countries

Developing nations like India and China argue that CBAM disregards the principle of “Common But Differentiated Responsibilities” (CBDR), a core tenet of the UN Framework Convention on Climate Change (UNFCCC). This principle acknowledges that developed nations, having historically contributed more to global emissions, should bear a greater burden in tackling climate change.

India’s exports to the EU were valued at US$ 75 billion in 2022–23, comprising over 15% of its total exports. As such, CBAM’s implementation—set to begin in January 2026 with a transition phase that started on October 1, 2023—is likely to have a significant impact on Indian industry.

Finance Minister Nirmala Sitharaman and Commerce Minister Piyush Goyal have repeatedly called CBAM “unfair” and a a breach of the “common but differentiated responsibilities” (CBDR) principle established under multilateral climate agreements. (Established under the UNFCCC, this CBDR principle recognizes that while all countries are responsible for tackling climate change, the extent of their obligations should reflect their individual capacities and circumstances.)

 India’s response: Carbon Credit Trading Scheme (CCTS)

The draft UK-CBAM legislation specifies the method for calculating emissions and setting the CBAM rate, which will be determined using sector-specific carbon prices aligned with the UK Emissions Trading Scheme. 

To prepare for carbon compliance and align with its climate commitments under the Paris Agreement (2015), India introduced the Carbon Credit Trading Scheme (CCTS) in 2023.

Key Features:

1. Tailored to a developing economy, CCTS operates on emissions intensity rather than absolute emissions—unlike Western systems.
2. The scheme supports emissions reduction in energy-intensive industries by allowing entities to trade carbon credits.

While not yet operational, the Ministry of Environment, Forest and Climate Change issued the Draft Greenhouse Gases Emissions Intensity (GEI) Target Rules, 2025, on April 16, 2025. These rules will create a compliance framework for CCTS.

The scheme will include:

• A compliance mechanism: Obligated industries that meet reduction targets will receive Carbon Credit Certificates.
• An offset mechanism: Non-obligated entities can register voluntary projects that reduce, remove, or avoid GHG emissions to earn credits.

India has preserved its right to respond

Under the recently concluded Free Trade Agreement (FTA) with the UK, 99% of India’s exports will receive duty-free access to the British market. In exchange, India has agreed to gradually reduce tariffs on 90% of its tariff lines and extend concessions on products such as automobiles, whiskey, and gin. 

However, the FTA text does not clarify whether these duty benefits for India will be impacted by the UK’s proposed carbon tax, set to take effect in 2027. 

Although the agreement includes no exemption from the UK’s Carbon Border Adjustment Mechanism (CBAM), officials stated that India has retained the right to retaliate against any additional taxes imposed under it.