The European Union’s introduction of the Carbon Border Adjustment Mechanism (CBAM) is a significant development in global trade and climate policy.
Under the CBAM, starting in 2023, importers to the EU must report carbon emissions for certain carbon-intensive goods, such as steel, cement, fertilizer, aluminium, electricity and hydrogen. By 2026, CBAM will be fully integrated with the EU’s Emissions Trading System (ETS), requiring importers to purchase carbon certificates for goods that exceed EU emission limits, effectively equalising carbon costs. By 2030, the CBAM’s scope will expand to include all industries, including textiles — Pakistan’s largest export sector.
The repercussions of the CBAM extend to all major exporting nations relying on carbon-intensive industries. Exporters of steel and aluminium manufacturers are experiencing increased costs in the EU due to CBAM and in the US due to President Trump’s tariffs (US tariffs have no link with carbon emission), potentially disrupting trade patterns and global supply chains.
However, President Trump and the EU are not the only ones who are introducing tariffs. The UK is developing a similar carbon border adjustment tax, expected to align closely with the EU’s mechanism. Canada has been actively considering comparable policies, and signals from China also reveal that it will develop its version of CBAM. Thus, the global trend is clear: carbon intensity is now a central consideration in international trade policies spurring a global shift toward carbon pricing and greener supply chains.
At the moment, only about 1.23 per cent of Pakistan’s exports to the EU are in the sectors initially covered by the CBAM. Its primary exports to the EU, such as textiles and clothing, are not immediately affected. However, the CBAM's scope may expand to include these sectors post 2026. Energy-intensive manufacturing practices, reliance on fossil fuels and inefficient resource management may render Pakistani exports less competitive unless substantial environmental compliance measures are swiftly adopted. This puts pressure on exporters to cut their carbon footprint to retain access to the EU (and all other) market(s).
One practical strategy to avoid paying carbon taxes in the EU is implementing domestic carbon pricing. Incidentally, Pakistan is considering introducing a domestic carbon tax or levy. The International Monetary Fund (IMF) has recommended a carbon tax as a means to bolster revenues and as a policy measure to secure funds through its Resilience and Sustainability Facility. The IMF estimates that a carbon tax of $25 per ton of CO2 could generate approximately 1.2 per cent of Pakistan’s annual GDP, simultaneously discouraging emissions through financial incentives.
Conceptually, a carbon tax assigns monetary value to emissions, compelling businesses and individuals to reduce their carbon footprints and adopt cleaner technologies. It aligns with the 'polluter pays' principle, ensuring environmental accountability while generating funds for sustainable development projects and promoting environmental equity.
Yet, Pakistan’s carbon tax policy remains uncertain, particularly regarding its alignment with broader climate goals versus purely revenue-driven motivations. In a scenario where solar energy usage is discouraged to maintain capacity payments to fossil fuel-based power producers, doubts arise about the effectiveness of such a tax in genuinely reducing emissions.
Further details on Pakistan’s carbon tax await the finalisation of a staff-level agreement (SLA) with the IMF. Early indications suggest potential taxes on fossil fuels (diesel, gasoline) and internal combustion engines, which could raise energy prices and vehicle registration costs.
Whatever form such a tax takes, its effective implementation and compliance with CBAM requirements require extensive preparation. Pakistan currently lacks the institutional capacity and technical expertise needed to monitor and verify emissions effectively. Exporters will need reliable Monitoring, Reporting and Verification (MRV) systems, along with international certifications such as ISO 14065, to accurately measure their carbon footprints.
Concerns about economic competitiveness remain significant, since many Pakistani industries are already struggling with high energy costs. A poorly designed carbon tax could further burden businesses without effectively reducing emissions, especially if cleaner alternatives are unavailable. Transparent and well-structured policies are essential to ensuring the tax drives meaningful environmental progress without disproportionately harming industries or consumers.
Administrative capacity is another concern. Pakistan’s tax machinery already struggles with existing levies, so enforcing a carbon tax could be difficult. Clear rules on what is taxed and at what rate will be needed, along with steps to prevent evasion and to shield lower-income households from higher energy costs.
While the prospect of paying a carbon tax is acceptable, its effectiveness depends greatly on how revenues are used. A credible policy would ring-fence funds explicitly for greening the economy and meeting Pakistan’s nationally determined contributions (NDCs). However, there is justified concern that revenue from carbon taxation might instead bridge fiscal deficits without adequately supporting climate adaptation and mitigation efforts.
Despite these challenges, a well-structured carbon tax could significantly benefit Pakistan. Studies indicate that a carbon tax of around $20 per ton could reduce Pakistan’s emissions by up to 36 per cent by 2050. The tax could generate considerable public revenue, funding renewable energy infrastructure, sustainable projects, and social initiatives. Reduced fossil fuel consumption would also decrease import bills, improve air quality, and yield better public health outcomes, indirectly supporting foreign exchange reserves.
To be CBAM-compliant and effectively implement a domestic carbon tax, Pakistan should adopt strategic measures. It is essential to integrate the carbon tax into a broader carbon pricing strategy that aligns with Pakistan’s climate commitments, such as forthcoming NDCs 3.0 (third iteration of our Nationally Determined Contributions). Engaging stakeholders, including industries and civil society, will ensure transparency and gather widespread support.
Transparency regarding revenue use is crucial. Clearly communicating that carbon tax proceeds will fund renewable energy, energy efficiency and cleaner industry practices will build public trust and directly support the green transition, mitigating any regressive effects.
Supporting key industries in reducing emissions is also very important to become CBAM-compliant. Major export sectors require technical assistance and financial incentives to adopt clean energy, efficient machinery and cleaner production processes. Such transitions enhance their competitiveness in markets increasingly sensitive to carbon footprints.
Securing international support is equally vital. Leveraging diplomacy to obtain technical assistance, technology transfers and climate finance from the EU, China and other international actors can facilitate Pakistan’s shift to greener industries.
Likewise, capacity building and awareness initiatives are also important for successful implementation. Training officials in climate and trade issues, alongside educating businesses on CBAM and upcoming carbon pricing, will accelerate preparedness and investment in sustainable practices.
Climate policy and trade are now linked; the EU’s CBAM makes clear that sustainability is no longer optional but a requirement for growth. Pakistan, highly vulnerable to climate change and dependent on carbon-intensive industries, must recognise these developments as catalysts for urgently transitioning towards a green economy.
While challenging, such a transition offers opportunities to modernise the industry, attract sustainable investment and safeguard future market access.
This is not about pleasing foreigners; it is about future-proofing our own economy, ensuring our economic trajectory aligns with the reality of a warming world.
The writer heads the Sustainable Development Policy Institute (SDPI) and is a member of the advisory board of the Asian Development Bank Institute. He tweets/posts abidsuleri