The EU and India concluded FTA negotiations in January 2026, just as the EU’s Carbon Border Adjustment Mechanism entered its definitive financial phase. In this post, Banerjee and Morotti argue that while the two policies are not inherently at odds, differences in how the EU and India measure and recognise carbon costs risk saddling Indian exporters with a double compliance burden – eroding potential gains from the trade deal.
On 27 January 2026, the European Union (EU) and India reached a significant milestone with a successful settlement of negotiations for their long‑awaited Free Trade Agreement (FTA), which stands to be one of the EU’s most consequential trade deals (Press Information Bureau (PIB) , 2026a). Yet, only days earlier, the EU’s ‘Carbon Border Adjustment Mechanism’ (CBAM) entered its definitive financial phase, introducing a new layer of complexity into this evolving relationship (World Economic Forum (WEF), 2025). The two policies are not inherently contradictory: the EU has legitimate reasons to address carbon leakage from its trade partners through trade-related climate measures, just as India has legitimate reasons to pursue domestic emissions reductions through its own pathway – given its developmental priorities, reliance on coal in the current energy mix, and institutional capacity. The policy challenge arises when the two systems measure and recognise carbon costs differently.
For India, this creates the risk of a potential double burden. Indian exporters may have to comply with domestic emissions regulations while also meeting the EU’s CBAM requirements, even when the two systems pursue broadly similar mitigation objectives through different institutional and measurement frameworks. The central question, therefore, is not whether environmental conditions should form part of modern trade policy, but whether different approaches to carbon regulation can be harmonised sufficiently to avoid duplicative compliance costs and preserve the intended gains from trade liberalisation. This distinction matters because the economic burden of border adjustment depends not only on the existence of a carbon price, but also on how domestic and border carbon-pricing systems interact. Earlier research on India suggested that greater convergence between domestic and border carbon adjustments could reduce the economic costs of compliance while improving the effectiveness of mitigation policy (Banerjee 2021).
Therefore, the real test before this India-EU partnership is whether both sides can harmonise deeper economic integration with the emerging framework of carbon-sensitive trade regulations (Arora 2026).
Mother of all deals
The strategic motivation behind the EU-India trade negotiations for this agreement, particularly in the current fragmented world, is not purely commercial. The EU sees India as a strategic China+1 candidate due to its democratic stability, demographic dividend, public sector-backed manufacturing ecosystem, cost advantages in industrial inputs and labour (lower wages and production costs) and technological depth (ET2C, 2026). The deal locks in preferential access for European firms eyeing Indian markets and for Indian firms seeking to integrate into European value chains (Hinz et al. 2026). In that context, an ambitious EU-India trade agreement carries both geopolitical and economic significance, which explains why leaders on both sides have described it as the ‘mother of all deals’ (WEF, 2026).
The agreement establishes a massive free-trade zone, referencing Article XXIV of the General Agreement on Tariffs and Trade (GATT) and V of the General Agreement on Trade in Services (GATS) in the very first chapter of the trade deal, complying with the WTO principles (European Commission), spanning a combined market of nearly two billion people and aiming to double the EU’s goods exports to India by 2032 while giving a major boost to Indian labour-intensive sectors, including MSMEs (micro, small, and medium enterprises). The agreement features extensive tariff liberalisation tailored to benefit both economies: The EU will scrap tariffs on 90% of Indian goods immediately at launch, while India will eliminate tariffs on 86% of its tariff lines, covering 93% of imports from the EU. Including partial cuts, this FTA will deliver some form of tariff concession to 99% of bilateral trade between these two regions.
Carbon-conditioned market access
The reputation of the EU as a prolific regulator is well-established in a wide spectrum of policy space, reflecting the European commitment to develop a new model of market-based mitigation scheme (Erdogdu 2025, Espa et al. 2022). The EU’s CBAM extends the emission penalisation mechanism, already operational internally under the Emission Trading System (ETS) beyond European borders by requiring importers of emission-intensive products to purchase carbon certificates linked to European carbon prices. During FTA negotiations, the EU refused to grant India any exemption from the mechanism (Bercero and Sapir 2025). As a result, tariffs may disappear at the border, but carbon costs re-enter through regulatory compliance requirements and threaten to neutralise tariff-free gains from the FTA.
CBAM therefore introduces an additional regulatory layer that may affect the gains from trade, targeting India’s key heavy industries such as steel, aluminium, cement, and fertilisers. Iron and steel account for the overwhelming majority of India’s CBAM-exposed trade with the EU (Majumder et al. 2025, Banerjee 2021). However, the concern is not that the EU should refrain from environmental conditions in trade, but that differences in the measurement and recognition of carbon costs may result in Indian firms bearing the costs of compliance with two partially overlapping systems.
The EU argues that the CBAM remains compatible with WTO obligations under Article II.2(a) of the GATT, which permits border adjustments linked to internal taxation (Kleiman and Pauwelyn 2020). Under CBAM Regulation 2023/956, importers must purchase carbon certificates reflecting the EU-ETS allowance price (for Q1 2026, US$88 per metric tonne of CO2 equivalent) (European Commission, n.d.-e). Yet, implementation remains politically sensitive. Under Article 2(4) of the Regulation, CBAM does not apply to imports originating in countries and territories listed in Annex III (EU, 2023). These currently include Iceland, Liechtenstein, Norway, and Switzerland, which either participate in or have emissions trading systems formally linked to the EU-ETS. India is not on that list.
A central question, therefore, is whether CBAM’s failure to offer India a free pass complies with the WTO’s non-discrimination principle. This principle includes the most-favoured nation and national treatment rules, especially if other strategic trade partners are offered easier adjustment pathways or indirect flexibility.
Compliance capacity and adjustment costs
Indian exporters face a structural disadvantage under the CBAM. As free allowances are no longer granted to the EU producers, with zero tariffs at the border, an Indian tonne of steel would not face a higher carbon cost than a German one per se. However, the EU producers had the opportunity to adapt earlier than the Indian exporters, benefiting from interim relief (free allowances) under the EU-ETS during the CBAM formulation phase. Implementation, not merely legal design, will determine whether Indian exporters compete on a level playing field or face a carbon tilt.
For Indian primary steel, the default emission intensity under CBAM (4.32 tonnes of CO₂ per tonne of steel) is nearly double the national average (Reclimatize, 2026, PIB, 2024). Without verified emissions data, Indian exporters pay a penalty. But for MSMEs, which account for around 40% of Indian steel production, monitoring, reporting and verification (MRV) systems are prohibitively expensive. The cost of third‑party verification, the complexity of calculating embedded emissions for disaggregated supply chains, and the risk of penalties for non‑compliance all function as de facto non‑tariff barriers. The FTA’s tariff cuts cannot compensate for these if Indian firms cannot clear the CBAM threshold.
Domestic carbon pricing and policy convergence
India secured a commitment that any flexibility or dilution the EU grants to other trading partners under CBAM will automatically apply to India too. Under Article 31 of the CBAM regulation, the EU has committed to gradually phase out the CBAM burden and has pledged to adjust the calculation of CBAM-related tariffs in order to account for free allowances and refrain from imposing an undue, asymmetric burden on foreign importers.
Years before, when developing countries were busy questioning the EU’s legitimacy in preventing carbon leakage when different forms of the Border Carbon Adjustment (BCA) were in the discussion stage, this aspect was rarely highlighted beyond a WTO legal challenge. The credibility of climate ambitions had taken a backseat and the issue of domestic carbon adjustment remained an underprepared alternative. A carbon adjustment study on India by Banerjee (2021) examined precisely this configuration: the closer the border and domestic carbon rates converge, the more effective the overall carbon adjustment scheme, and the less economically painful for the developing country. Convergence reduces the compliance burden because Indian firms already internalise a carbon cost close to the EU level.
The EU‑India FTA and CBAM are not irreconcilable. But without an increasing policy convergence, the former’s benefits will be eventually eroded by the latter’s costs. The growing inevitability of a domestic carbon adjustment is increasingly motivating India to launch the Carbon Credit Trading Scheme (CCTS) under the Energy Conservation (Amendment) Act 2022, which now sets emission intensity targets for 490 industrial units across seven sectors (PIB, 2026b). Trading is expected to begin by October 2026. This represents India’s first serious attempt to build a domestic carbon-pricing architecture compatible with emerging global trade realities.
The CCTS offers a potential pathway towards policy convergence. If carbon costs effectively incurred by Indian producers under the CCTS can be recognised under the CBAM framework, the number of CBAM certificates required by Indian exporters could fall, subject to the EU’s rules on verification and recognition of carbon prices paid in third countries. The net trade effect of tariff liberalisation combined with carbon-adjustment costs therefore remains an open empirical question that may differ sharply across sectors, technologies and firm types.
Another pivotal question underlying this debate is whether an absolute emissions-cap framework (the EU-ETS) can be reconciled with an emissions-intensity-based approach (India’s CCTS). The eventual formula of compatibility between these two mitigation architectures may determine the future direction of policy convergence between the two economies.
For the EU, the issue is not simply environmental credibility. If carbon-conditioned trade governance becomes excessively rigid or unevenly implemented, Europe risks weakening the very industrial partnerships and supply-chain diversification strategies it seeks to cultivate through its India strategy. Two concrete steps are recommended. First, India should work with the EU towards a framework under which verifiable carbon costs incurred under the CCTS can be recognised for CBAM purposes, while developing partnerships with the EU to accelerate technological upgrading. Second, the EU should fund MRV infrastructure for Indian MSMEs in CBAM‑covered sectors. If CBAM implementation disproportionately burdens Indian exporters, the EU risks weakening precisely the supply-chain diversification and industrial partnership objectives that motivated the FTA in the first place.
Suvajit Banerjee is Fellow at NCAER and Tommaso Morotti is a dual-degree graduate student at Bocconi University and the Rockefeller College of Public Affairs and Policy. Views are personal.
