Carbon markets can help to reduce greenhouse gas emissions by combining a price on carbon and tradeable certificates to incentivise low-carbon investment. They come in many forms, depending on who participates and how money and credits change hands – including voluntary or mandatory (also known as ‘compliance’), and national or international.
International carbon markets are at a critical juncture. Negotiations at COP27 on mechanisms for carbon trading under Article 6 of the Paris agreement took some steps forwards and the first intergovernmental trades have been announced, but many rules remain undecided.
Meanwhile, major initiatives were launched seeking to leverage voluntary private demand for carbon credits. The US-led Energy Transition Accelerator aims at stimulating demand for carbon credits in developing economies at national or subnational levels, while the Africa Carbon Markets Initiative seeks to scale up carbon credit revenues for African countries.
In this context, governments in developing economies must consider how best to use carbon markets to achieve their climate and development goals. Some, such as Jordan and Ghana, have developed frameworks to facilitate capital inflows for climate mitigation in exchange for carbon credits.
India’s emissions are the third-largest globally (although much lower in per capita terms), and its government is taking comprehensive action to reach its goal of net zero by 2070. However, rather than defining plans to harness international carbon finance, India’s Energy Conservation (Amendment) Bill focuses on developing a domestic carbon market. There is a logic to this approach, but certain design features pose risks to effective decarbonisation in India.
The central government’s Bureau of Energy Efficiency released a draft blueprint on its national carbon markets, primarily targeting high-emitting sectors: energy, steel and cement. State authorities will issue certificates for emissions performance of various regulated entities. The new scheme will first look to tackle an oversupply of certificates (reflecting insufficiently stringent targets) by expanding the pool of actors who are eligible to register and buy them. Next, voluntary projects will be allowed to supply credits to raise investment more widely in low-carbon solutions.
Linking existing compliance schemes to voluntary demand and supply could undermine integrity on both sides. The credits that companies buy to meet voluntary goals should represent purely ‘additional’ reductions, not cuts mandated by policy. Access to a supply of cheap voluntary credits could undermine the price signal in the final phase, in which policy-makers intend to move to a mandatory cap-and-trade system (akin to the European Union’s Emissions Trading System).
Governance and institutional capacity then become a concern. While the two phases give policy-makers time to build infrastructure and capacity gradually, India’s track record with compliance schemes is marked by inconsistent procedures and implementation.
An effective pricing mechanism requires strong political will to set up tight emissions targets, a national carbon registry and clear cross-ministerial responsibilities. By building a robust system of monitoring, India can avoid potential pitfalls like inadvertently increasing energy intensity, corruption and double counting of credits.
International market participants grew anxious in August when Minister of Power, New and Renewable Energy Raj Kumar Singh announced a ban on India’s exports of carbon credits. As of Q3 2022, India had issued over 170Mt carbon dioxide equivalent of credits – the vast majority for renewable energy deployment – according to data from Allied Offsets.
Singh later clarified that some exports would be allowed once India meets its revised nationally determined contribution. By focusing on a domestic market, India may forego a larger role for international finance and derail private investment.
However, India is not the only country to display caution towards carbon credit exports: Honduras and Indonesia are other prominent examples. A guarded approach reflects two factors.
First, countries selling credits for use as offsets via Article 6 must adjust their emissions inventory accordingly. Mixed views on whether independent standards should follow the same rules creates enough ambiguity to make policy-makers nervous about the impact of credit exports on their climate commitments.
Second, host governments and local communities are likely to receive less value from credits issued by international actors. States can define rights to generate, own and use carbon credits and their legal and tax status, but assertive treatment by host governments may lead to reduced inflows in competitive markets. Yet although greater investment flows seem welcome, some observers are sceptical whether donor countries might use credit purchases to mitigate shortfalls in their climate finance contributions.
The Indian government is rightfully considering how carbon markets can support its goals across multiple time horizons. However, policy-makers must prioritise improving markets’ design before advancing to trading – by fixing integrity issues in existing schemes, clarifying governance responsibilities and building infrastructure for transparency. They should seek synergy, not complete integration or overlap, between voluntary and compliance markets. India should clarify the conditions, if any, under which it encourages international investment, in the context of Paris rules and the wider climate finance architecture.
Kamya Choudhary is India Policy Fellow and Rob Macquarie is Policy Analyst and Research Adviser to Lord Stern, Grantham Research Institute on Climate Change and the Environment, London School of Economics.
This article was originally published in the Sustainable Policy Institute Journal, Winter 2023 edition.
