India’s growth trajectory reflects a strong commitment to both economic growth and environmental sustainability. A key element in its decarbonisation strategy is the development of a domestic carbon market, which is crucial for unlocking new mitigation opportunities and driving demand for low-carbon solutions. Carbon markets serve as a key platform for climate finance. By pricing carbon emissions, they incentivise investment in low-carbon technologies and projects, accelerating the transition to a more sustainable economy.
In line with its climate objectives, India has set ambitious targets following the ratification of the Paris Agreement in 2016, which aims to keep the global average temperature rise to well below 2 °C by the end of the century. Initially, India committed to reducing its greenhouse gas (GHG) emission intensity by 33-35 per cent by 2030 from 2005 levels, but in August 2022, it enhanced its target to 45 per cent. These targets highlight the critical role of carbon markets in climate financing, as outlined in Article 6 of the Paris Agreement. Article 6.2 further establishes a foundation for international carbon trading, which involves the buying and selling of emission reduction credits across borders.
A well-structured and ambitious carbon market can significantly enhance the financing of Indian industries’ low-carbon transition, while also providing micro, small and medium enterprises (MSMEs) access to funding and technology, which drive the decarbonisation of the MSME manufacturing sector. Carbon markets facilitate this transition by enabling the trading of carbon dioxide equivalent (CO2e) emissions. They operate through two main systems — compliance systems, such as the emissions trading systems (ETS), which cap total emissions and allows the trading of allowances, and voluntary systems, which enable entities to offset their emissions by purchasing carbon credits. These markets are managed by independent standards or non-governmental organisations, which oversee the trading of carbon credits from projects aimed at reducing or sequestering GHG emissions, thereby supporting the financial mechanisms essential for achieving climate goals.
This article critically evaluates the role of carbon markets in India, analysing recent policy guidelines and drawing insights from both global and domestic experiences. It identifies strategies for leveraging the carbon market to decarbonise key sectors and finance the energy transition.
Evolution and growth of carbon markets
The evolution of carbon markets began in 1990, when the US government launched an early cap-and-trade system, setting a precedent for global carbon trading and initiating discussions on carbon markets. The 1997 Kyoto Protocol introduced the first international carbon market, aiming to reduce greenhouse gases, significantly shaping carbon trading approaches globally.
Building on these early efforts, the European Union (EU) introduced the Emissions Trading System in 2005, becoming the world’s first carbon market. European countries favoured carbon trading over carbon taxation, finding it challenging to harmonise international tax policies and facing resistance from industries with high emissions. A proposed unified EU-wide CO2 tax was shelved in 1992, paving the way for emissions trading schemes influenced by the US.
Recent trends highlight the growing significance of these markets in financing climate action. The voluntary carbon market has witnessed substantial growth, with its value rising from $500 million in 2020 to $2 billion in 2021, and projections suggest it could reach up to $40 billion by 2030. Additionally, the World Bank’s annual “State and Trends of Carbon Pricing 2024” report reveals that carbon pricing revenues reached a record $104 billion in 2023. This revenue, generated from 75 carbon pricing instruments globally, has been largely reinvested in climate-and nature-related programmes, underscoring the critical role of carbon markets in supporting global climate strategies.
Development and progress of India’s carbon market
To ensure India stays on track, the Indian Bureau of Energy Efficiency developed a carbon market blueprint modelled on the EU Emissions Trading System, reflecting a global trend towards similar systems seen in countries like Switzerland, Korea, New Zealand, California and China. Further, the Indian government amended the Energy Conservation Act, 2001, through the Energy Conservation (Amendment) Bill, 2022, to establish a legal framework for carbon credit trading. This amendment is aimed at incentivising emission reductions by allowing entities to register as “registered entities” within the carbon credit trading scheme. Both individuals and entities will have the option to purchase energy saving certificates (ESCerts) or carbon credit certificates on a voluntary basis, with these certificates issued by the central government or an authorised agency. Despite some challenges, Indian stakeholders have been actively participating in compliance markets, such as the Perform, Achieve and Trade (PAT) scheme with ESCerts and renewable energy certificates, as well as voluntary projects like the Clean Development Mechanism, where India ranks second globally in registered projects. Since 2015, the PAT scheme has contributed to a CO2 emission reduction of over 106 million tonnes.
In addition, India is advancing its carbon market initiatives through a national framework for the Indian carbon market, which includes both a compliance mechanism for the energy and industrial sectors and an offset mechanism for voluntary GHG reductions. The carbon credit trading scheme, overseen by the National Steering Committee for the Indian carbon market, allows non-obligated entities to register projects that reduce or avoid GHG emissions, with carbon credit certificates issued based on project evaluations.
Challenges
Carbon markets face several complex challenges that can undermine their effectiveness. A major issue is carbon leakage, where countries reduce their emissions by investing in renewable energy, such as wind farms, but sell their freed-up carbon allowances to other countries. This dynamic can result in capital and production shifting to countries that do not have cap-and-trade systems or stringent emissions regulations. As a result, when one country reduces its emissions by investing in renewable energy projects such as wind farms, it inadvertently allows other countries with less rigorous environmental standards to
increase theirs, undermining global emission reduction efforts.
In addition, the effectiveness of incentive-based approaches like forest carbon offset programmes in developing countries is often debated. Critics argue that these programmes frequently overlook significant governance and enforcement challenges. In politically and economically unstable countries, revenue from environmentally harmful industries may be too crucial to forgo, complicating the implementation and sustainability of these initiatives. Moreover, unstable governments may struggle with enforcing regulations and managing projects, leading to inadequate oversight. Economic distress can also lead to a prioritisation of revenues from industries such as logging or mining over forest conservation efforts.
Market structure itself presents challenges, as large corporations can find loopholes, opting to buy carbon allowances rather than reduce their emissions, thereby encouraging greenwashing.
Moreover, cap-and-trade schemes risk increasing energy prices and the cost of essential goods, disproportionately burdening low-income households and exacerbating economic inequalities.
Furthermore, the lack of harmonisation between different carbon markets complicates international coordination and reduces market efficiency. Measurement issues also pose challenges as the “right price” for carbon remains vague and often misaligned with theoretical models. Carbon pricing mechanisms are also expected to influence global trade patterns. Critics argue that while the EU seeks to lead in climate action, the carbon border adjustment mechanism may also serve as a protectionist measure, imposing significant burdens on less developed countries.
The way forward
The 2017 report by the High-Level Commission on Carbon Prices, led by Joseph Stiglitz and Lord Nicholas Stern, outlined key recommendations for advancing carbon pricing. It called for reducing or eliminating fossil-fuel subsidies, establishing financial incentives for low-carbon projects, and utilising carbon pricing revenues to support vulnerable populations and invest in infrastructure like public transport and renewable energy. The report emphasised the need for countries to customise their carbon pricing instruments to fit their unique circumstances, resources and needs.
In light of these recommendations, India must chart its own course for developing an effective carbon market. To align with global best practices, the country will need to draw lessons from successful cap-and-trade systems in regions like the EU and the US. As India gears up for the carbon border adjustment mechanism, it must accelerate its efforts to develop its carbon market. The country is set to launch trading in key sectors such as iron and steel, cement, petrochemicals, paper and pulp by April 2025.
Further, finance minister Nirmala Sitharaman’s speech for the 2024-25 budget, mentioned plans to introduce measures for the transition of hard-to-abate sectors from the current Perform, Achieve, and Trade (PAT) scheme to the forthcoming Indian Carbon Market (ICM).
For the Carbon Credit and Trading Scheme to succeed, India must carefully define the emissions cap and its reduction trajectory, engage with industry stakeholders and consider technological capabilities. Cap-and-trade systems reduce emissions by setting a maximum allowable emissions cap, which is progressively lowered over time. Hence, transitioning to a cap based on absolute emissions is likely to enhance market credibility and improve the system’s overall impact.
With a thoughtful and strategic approach, India is well positioned to create a robust carbon market that advances its climate goals and sets a global example in carbon market innovation.
By Mohammed Ali Siddiqi
