Developing a Framework for CGE Model: Analysing the Implications of CBAM

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This academic paper investigates the potential economic and social ramifications of the European Union’s Carbon Border Adjustment Mechanism (CBAM) on the Indian economy. CBAM, designed to mitigate carbon leakage and ensure a level playing field for EU industries, introduces a carbon price on imported goods, potentially impacting developing economies reliant on carbon-intensive exports. Given the complex economic structure and trade relationships of India, this study develops a model framework for a tailored Computable General Equilibrium (CGE) model—the CSEP-CGE—to assess CBAM’s multifaceted effects.

The paper begins by providing a comprehensive overview of CBAM, its evolution from the EU Emissions Trading System (ETS), and its potential implications for developing countries. Existing literature analysing CBAM’s impact often employs gravity models, input-output analysis, or accounting approaches, each with inherent limitations. This study argues that a CGE model provides a more comprehensive and nuanced analysis due to its ability to capture the interconnectedness of economic sectors, incorporate dynamic adjustments, and assess distributional impacts across diverse household income groups.

The CSEP-CGE model framework developed here utilises a detailed production structure, distinguishing between fossil fuel and non-fossil fuel sectors, along with varying substitution possibilities for inputs. This allows for an in-depth analysis of potential shifts in production methods and technology adoption in response to carbon pricing. The model is built on the CSEP Environmentally-extended Social Accounting Matrix (ESAM) 2019–20 for India, offering a rich dataset with disaggregated sectors, households based on income quintiles, and environmental factors. This enables a granular assessment of the impacts on GDP, employment, welfare, trade, emissions, and social equity.

A key contribution of this study lies in its incorporation of a specific breakdown of trade and customs
duties for EU and non-EU countries, addressing a gap in existing single-country CGE models analysing CBAM. This enables the assessment of trade diversion possibilities for Indian firms in response to CBAM. The model can further be utilised for examining the interplay between CBAM and existing domestic carbon pricing policies in India, exploring optimal strategies for carbon pricing and revenue recycling to minimise adverse effects and promote technological advancement in relevant sectors.

The CSEP-CGE model framework provides a valuable tool for policymakers to evaluate the complex
interplay of economic and environmental considerations associated with CBAM. It allows for the
exploration of diverse policy scenarios, including the absence of domestic carbon pricing, optimal carbon pricing strategies, and alternative policy responses such as tariffs or a global carbon policy. With its nuanced sectoral focus, household disaggregation, and specific trade breakdown for EU and non-EU countries, it offers a valuable resource for navigating the complexities of CBAM and its implications for the Indian economy. This can enable policymakers to examine the distributional impacts across different household income groups and thus design effective redistribution policies and promote an inclusive energy transition. Future research can utilise this model to further investigate specific sectoral vulnerabilities, assess the efficacy of various carbon pricing mechanisms, and explore alternative taxation strategies for revenue mobilisation to support a sustainable energy transition.

Q&A with authors

• What is the core message conveyed in your paper?

Carbon Border Adjustment Mechanism (CBAM) has been implemented by the European Union (EU) to curb carbon leakage and level the playing field for EU industries. This will impose a carbon price on imported goods, potentially impacting developing economies exporting carbon-intensive targeted products to the EU. India too may experience economic and social implications because of CBAM, which requires due consideration. This paper critiques existing methodologies such as the gravity model, accounting approaches, input-output, and argues that CGE models can better capture economic interdependencies and dynamic adjustments. The study highlights the need for a comprehensive CGE model which may capture the far-reaching impacts of CBAM on India and thus develop a CGE model framework for India which is built on the indigenously developed Environmentally-extended Social Accounting Matrix (ESAM) for India.

• What presents the biggest opportunity?

Starting January 2026, exports of targeted sectors to the EU will be subject to carbon prices. Formulation of domestic policies in this regard requires a detailed analysis of the possible impacts of CBAM on the Indian economy. This presents an opportunity to explore and utilise the CSEP-CGE model framework, as it incorporates a detailed trade and customs disaggregation for EU and non-EU countries, permitting analysis of distributional impacts of various government policies. By strategically responding to CBAM, India can foster resilience in trade and competitiveness in an increasingly decarbonised global economy. Since the CSEP-CGE model framework has been developed for India which uses a comprehensive ESAM 2019-20 dataset, it allows for the assessment of various fiscal and climate policies for India.

• What is the biggest challenge?

The CBAM poses significant implications for the Indian economy as it may increase compliance costs for industries reliant on EU markets, potentially undermining their competitiveness, reducing exports, and adversely impacting GDP. An accurate and comprehensive estimation of these effects on the Indian economy remains challenging, particularly when considering the potential for trade diversion due to CBAM and the need for adaptation measures. Some of these could be addressed by exploring the implications of CBAM and domestic carbon mitigation strategies that may be implemented in response to CBAM using the CGE structure developed for India.