Internalising the Externality: Carbon Pricing in India

India stands at a critical juncture in its development trajectory. As the world’s third-largest emitter, with CO2 levels reaching approximately 2.8 GtCO2 equivalent per year, around 7% of global emissions, New Delhi carries a significant burden of global climate responsibility. However, India’s climate action must be carefully aligned with its economic imperatives. 

Illustration by The Geostrata

Placing a price on carbon is generally regarded as a strategic step towards driving a low-carbon economy. It is an economically effective way of reducing greenhouse gas emissions. Moreover, the price signal could potentially channel dispersed economic decisions made by relevant entities into more productive outlets. Computing carbon in monetary terms can also help businesses include this data in their financial and planning strategies. 

In the context of India’s rapidly evolving economic and environmental landscape, carbon taxation must be structured with absolute precision, calibrated to the carbon intensity of industries, and integrated with complementary mechanisms such as Emission Trading Systems and Feebate Systems. Such a hybrid approach can ensure a more just and socially equitable distribution of decarbonisation burden across sectors and income groups.

For an almost risen Asian power like India, climate action and green transition are no longer discrete policy domains but are interwoven strands of a singular developmental narrative. 

However, climate change has significantly complicated India’s developmental ambitions, introducing a volatile disequilibrium between growth and environmental stewardship. This essay presents an integrated analysis that outlines carbon pricing theory in the Indian context, while simultaneously evaluating existing indirect and emerging instruments. 

Achieving Nationally Determined Contributions requires a 45% reduction of emissions’ intensity from 2005 levels by 2030, and attaining net zero by 2070, based on 500 GW non-fossil capacity. All this calls for policy innovation. Central to this is carbon pricing, which is a mechanism through which the externalities of carbon emissions are internalized. Yet, deploying it effectively in India requires navigating economic growth, equity, internal competitiveness, and political feasibility. There are several questions around how much one unit of carbon costs.

The way to go about it is by calculating the external cost of carbon, which is commonly referred to as the social cost. The social cost of CO2 is a comprehensive estimate of climate change damages, encompassing changes in net agricultural productivity, human health, property damages from increased flood risk, and changes in energy system costs, such as reduced cost for heating and increased cost for air conditioning. Morotomi argues that it is still a momentous task to gather accurate information on social marginal cost, and it varies from nation to nation depending on a multitude of factors. 

Bill Nordhaus suggests that carbon pricing via tax or cap and trade corrects for negative externalities, aligning private costs with social damages. The social cost of carbon for India stands at USD/86tCO2. India currently applies significant excise/VAT taxes on transport fuels. Similarly, the coal cess peaked at rupees 400/ tonne before it got absorbed into the GST fold in 2017.

OECD analysis places India’s carbon price at USD 16/tCO2 in 2021, which is distressingly far below the 64/tCO2 midpoint benchmark for Paris Agreement Alignment.

There also exist other crediting frameworks that facilitate the exchange of quantified climate mitigation outcomes. These credits are generated through various interventions. For instance, if a company engages in carbon sequestration activities or methane capturing from waste systems, these get translated as credits, which can then be used to compensate for their greenhouse gas footprints. 

INDIA'S COMPLIANCE CARBON MARKET

To optimally operationalise a national carbon pricing architecture, the Government of India unveiled comprehensive regulatory provisions in July 2024for its forthcoming compliance carbon market, structured under the carbon credit trading scheme.

These regulations crystallise the foundational design of India’s compliance-based emissions trading system, making a transformative advance in the nation’s evolving climate governance regime. The Bureau of Energy Efficiency, the central implementing authority, released an initial draft in late 2023, which was then subjected to rigorous consultation procedures with key industry, government, and civil society stakeholders. 

In India, the legal authority for establishing the domestic carbon market derives from amendments to the Energy Conservation Act, 2022.

This legislation confers the mandate upon the central government to authorise designated agencies to issue carbon credit certificates, each symbolising a verified reduction or removal of one tonne of carbon dioxide.

Under this framework, the Ministry of Power will act as the primary watchdog, while administrative operations will be with the Bureau of Energy Efficiency. This institutional configuration ensures technical rigour and policy coherence in the market’s development and execution. 

THE COMPLIANCE MECHANISM 

The compliance regime envisioned under CCTS is designed as an intensity-based, baseline, and credit system. Rather than imposing an absolute cap on emissions, this model requires obligated entities to meet progressively stringent greenhouse gas emissions intensity benchmarks. This structure is meant to align mitigation incentives with industrial growth trajectories, allowing some flexibility in achieving decarbonisation goals. 

In the earliest phase, the scheme will be targeting firms that are already participating in the Perform, Achieve and Trade (PAT) program, which is a longstanding mandatory energy efficiency initiative, launched under the National Action Plan on Climate Change (ESCerts), which creates energy savings certificates for 13 high-intensity sectors. Throughout the compliance mechanism will incrementally absorb additional sectors such as fisheries, ceramics and food processing, automobiles, and auto components. 

EMISSIONS COVERAGE

The inaugural phase of the CCTS compliance market will include nine high-emitting sectors currently regulated under PAT; they are– chlor-alkali, aluminum, cement, iron and steel, pulp and paper, petrochemicals, petroleum refining, and textiles. Subsequent phases will bring into their fold coal-based power generation industries. 

This system will be covering CO2 and Perfluorocarbons with provision for expanding emissions scope to other Kyoto-recognised greenhouse gases. Both direct emissions and indirect emissions from purchased electricity will be accounted for, thereby increasing the scope and comprehensiveness of the scheme. To guide the setting of targets, BEE will formulate sector-specific GHG intensity trajectories extending through 2030. 

CERTIFICATE ISSUANCE AND MARKET OPERATIONS

Each year, regulated entities will be assigned emission intensity baselines. Performance above the baselines will enable the concerned entities to receive carbon credit certificates, while underperformance will necessitate the acquisition of CCCs from the market to bridge the compliance gap. Surplus certificates can either be banked for future use or can be traded/sold in the secondary market.

The BEE will issue the CCCs, a trading will occur through accredited power exchanges with the national carbon registry serving as the ledger for tracking issuance, transfers, and retirements. Participation in trading will be mandatory for regulated or obligated entities, while for non-obligated entities, it shall remain voluntary. 

Furthermore, in parallel, the CCT also envisions non-obligated entities to register emission reduction, removal, or avoidance projects eligible for CCC issuance. This arm of the market is intended to catalyse mitigation beyond the compliance parameter. 

WHERE ARE WE TODAY?

The fact is that over 23% of global greenhouse gas emissions are now being covered under the various carbon pricing mechanisms. The total global value of carbon pricing instruments in operations is over 100 billion dollars every year. This indicates that there is still scope for positive expansion. The full operationalisation of India’s compliance carbon market is expected in 2026, thus marking a well-calculated pivot towards market-friendly climate mitigation. The 2025 World Bank report titled “State and Trends of Carbon Pricing” lauds India’s expanding role in global climate finance, and it indeed is a good omen. 

However, the road to implementation is riddled with conundrums of all sorts. The underlying notion of select carbon pricing mechanisms is that polluting activities can be tolerated as long as it is paid for. This enables wealthier and more influential firms to indulge in activities that are extremely detrimental to ecosystem health. Climate experts also argue that since the scheme only covers less than a third of emissions, it may not be sufficiently efficient in moderating GHGs.

India’s carbon credit trading system does not encapsulate the chief polluting sectors like agriculture and electricity, which is seen as a gaping hole in this policy outline. The delay in implementation is also at our disadvantage, as India may struggle to keep pace with other global carbon pricing mechanisms, which are in full swing. Indian exporters might also be scrutinised due to the long haul if our production means do not align with global standards/expectations. Therefore, an urgent imperative is to streamline the rollout before it's too late. 

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BY NAKSHATRA H.M

CENTRE FOR ENVIRONMENT AND CLIMATE ACTION

TEAM GEOSTRATA

info@thegeostrata.com