Will the EU’s New Green Regulations Punish Indian MSMEs?

The year is 1813. The British parliament has passed the East India Company Act, which ends the company’s monopoly over trade with India and opens it up to merchants outside London and the Company. The legislation encouraged textile manufacturers to export goods to the Indian market, which led to Indian craftsmen competing with machine-made goods and in the long run, resulted in the elimination of the Indian cotton industry.

Cut to 2024. The European parliament has passed the Corporate Sustainability Due Diligence Directive (CSDDD), a year after another environmental regulation, the Carbon Border Adjustment Mechanism (CBAM) came into force. The two are similar, yet distinct. Both aim to encourage global standards and affect supply chains in different ways.

CBAM, as part of Europe’s “green deal” initiatives, is already a bone of contention between the European Union (EU) and developing countries in Africa and Asia, with the latter accusing the EU of using environmental issues as a cover for trade protectionism. In India industry experts feel that the onus of net-zero ambitions should not fall on developing economies which need practical and equitable emission targets to continue on their growth trajectory.

Though these are still early days of CSDDD there are apprehensions that its consequences will be like that of CBAM.

New Laws of Nature

The CSDDD came into force on July 25, establishing mandatory human rights and environmental obligations for companies’ operations and supply chains and aiming to ensure that businesses are accountable for the impact at each point of their value chain. The regulation extends to the EU as well as non-EU companies that have an annual turnover of €450mn in the EU.

A closer look at CBAM, which came into effect on October 1, 2023, lays bare its effects on exporters from India. CBAM levies a tariff on carbon-intensive products that are imported to the EU. The regulation hopes to align prices of imported goods with those produced in the EU and contain “carbon leakage”, which involves companies transferring production to jurisdictions with less strict emissions policies.

A 2022 report by public policy think tank the Council on Energy, Environment and Water (CEEW) says CBAM could impact nearly 43% of India’s exports to the EU, worth $37bn. More than one-fourth of India’s exports of iron, steel and aluminium are to the EU, according to industry estimates. These are all hard-to-abate sectors and CBAM compliance can raise the cost of exports by 20–35%.

“CBAM relies on extensive data inputs and emissions tracing. Indian MSMEs [micro-, small- and medium enterprises] lack training for these processes. Therefore, India should proactively build an ecosystem to enhance MSME capacities and develop supportive policy frameworks for CBAM MRV [monitoring, reporting and verification] challenges,” says Aparna Sharma, programme lead, CEEW.

Different Measures

A day after the European parliament voted for CSDDD, India’s ministry of commerce began an exercise to identify infrastructure needs, sectors and clusters that would help achieve a $1trn merchandise export target by 2030. The exercise was carried out to ensure India met sustainability standards that would allow it to maintain its competitiveness and be a part of the global value chain. The EU is a key market for India and a bulk of exports include metals, textiles, chemicals, consumer electronics products, plastics and vehicles.

Research by the Indian Council of World Affairs reveals that India is the third largest exporter of aluminium in the world and the second-largest producer of steel. Nearly 20% of aluminium is exported to the EU, to which CBAM adds a 6% tariff and a 13% tariff on steel, resulting in an estimated loss of nearly $1–1.7bn revenue and reducing the competitiveness of Indian exporters. CSDDD will only add to the woes.

But Indian industry’s adherence to programmes promoting sustainability and transparency in value chains precedes CBAM and CSDDD. One of these is the set of certifications by the Aluminium Stewardship Initiative (ASI), a global non-profit that sets standards for aluminium. “Smelters in Jharsuguda, Odisha and Korba, Chhattisgarh have achieved the ASI’s performance standard certification. The ASI certification is a globally acknowledged sustainability standard for the aluminium industry. Jharsuguda smelter is also the first in the domestic industry to secure ASI’s chain of custody certification,” John Slaven, chief executive, Vedanta Aluminium tells Outlook Business. Its ASI certification has been in effect since 2017.

Green Geopolitics

The textile sector, too, is preparing to cut back on carbon emissions through a series of capacity building programmes that can benefit manufacturers, particularly in the MSME segment. The sector is making use of block chain technology in each step of its production process to map traceability.

“Tiruppur produces 1,950MW [megawatts] wind and solar power, surpassing its own needs. Nearly 65% of the six-lakh-strong workforce here constitutes semi-literate rural women,” says KM Subramanian, president of Tiruppur Exporters’ Association, which comprises 1,289 units exporting knitwear.

“As far as compliance with labour laws is concerned, India should ask ILO [International Labour Organisation] if competing countries such as Bangladesh and Vietnam do well on those parameters?” says Mithileshwar Thakur, secretary general of Apparel Export Promotion Council (APEC). He adds that India’s compliance with environmental, social and governance (ESG) regulations is high compared to other countries.

The indignation among various Indian MSME groupings is palpable as the EU regulations reek of protectionism.

“Regulations such as CBAM and CSDDD, which impose tariffs and seek compliance to sustainability standards set by EU are unfair for developing countries. EU’s ambition to reach net-zero greenhouse emissions by 2050 cannot be fulfilled by putting developing economies such as India on the line,” says Animesh Saxena, former president of Federation of Indian Micro and Small & Medium Enterprises (FISME).

Analysts have warned that the deadlock over carbon emissions can strain bilateral trade and affect negotiations around the India-EU free trade agreement. “EU has been doing everything possible to create a complex web of regulations in the garb of carbon neutrality,” says APEC's Thakur. Developing nations including India have been pointing to the Paris Agreement of 2015, which allows for greater flexibility in emission targets for them, but so far EU has not seemed willing to budge.

Thakur goes on to add that though CSDDD seems to impact only a few large companies, in reality it will impact even the smaller ones as they are a part of the supply chain in the capacity of contractors and subcontractors. “Regulations such as CBAM and CSDDD lead to increased price points for manufacturers; they require a lot of operational adjustments and in case of non-compliance it can even lead to termination of contract and legal action. The consequence, therefore, is enormous,” he says.

A Transition Plan

As climate consciousness increases and global targets become more stringent there have been calls for India to develop indigenous guidelines such as implementing its own carbon tax. A national emission trading system will enhance export competitiveness while encouraging industries to invest in technologies aimed at carbon reduction.

Reducing emissions can help industries earn credits that can be traded, potentially serving as an additional revenue stream. This initiative can promote domestic investment as well as open up avenues for foreign investment through the trading of carbon credits with other countries.

Dipankar Ghosh, partner and leader, sustainability and ESG business advisory services at BDO India, a professional services firm, says, “While stringent requirements may be viewed as a challenge, this also creates an opportunity for Indian businesses to align with global sustainability goals. By meeting these standards, Indian exporting companies can improve their resilience.”

CSDDD and CBAM are EU’s non-tariff trade barriers. Similar regulations are underway in the US and other countries. If India wants to stand firm on its grounds of sustainable development while maintaining global competitiveness, it must learn to navigate the troubled waters of the new global order.