Can Domestic Carbon Markets Buffer the Impact of EU Border Taxes? A Stochastic Frontier Analysis of Decarbonization Costs in India’s Energy-Intensive Industries

Abstract

This study examines the vulnerability of India’s energy-intensive and trade-exposed (EITE) industries to the European Union’s Carbon Border Adjustment Mechanism (CBAM) and evaluates whether a domestic emissions trading system (ETS) can mitigate these risks. Using data from the Annual Survey of Industries for 2015 to 2022, we estimate sector-level marginal abatement costs (MACs) using a stochastic frontier translog hyperbolic distance function. Results indicate a decline in technical efficiency over time and substantial heterogeneity in abatement costs across industries, with shadow prices ranging from USD 54.8/tCO 2 in cement to USD 453.9/tCO 2 in coke ovens (average: USD 238.3/tCO 2 ). MACs are negatively associated with carbon intensity, although formal tests provide limited evidence of a statistically significant non-linear relationship. Projected MACs remain relatively stable through 2030 under alternative decarbonization pathways. To assess trade-related risks, we construct a composite CBAM vulnerability index using carbon intensity, trade exposure, and economic dependence. Aluminium emerges as the most vulnerable sector, followed by iron and steel, while cement and chemicals exhibit comparatively limited exposure. ETS simulations indicate that low-cost sectors become permit suppliers as carbon prices increase. The findings suggest that a well-designed domestic carbon market, complemented by targeted support for vulnerable industries, can lower the overall cost of decarbonization, strengthen competitiveness, and enhance resilience to emerging carbon-related trade measures. JEL Classification: Q52, Pollution Control Adoption and Costs; Distributional Effects; Employment Effects; Q54, Climate; Natural Disasters and Their Management; Global Warming; Q58, Environmental Economics: Government Policy