Today, India, as one of the leading economies in the Global South, is faced with an unprecedented challenge of balancing the dual path of economic growth and meeting its climate goals. Rapid decarbonisation requires substantial investment in renewable technologies, energy efficiency enhancement, and building institutional capacity. However, the inadequacy of financial commitments from the developed world prevents many developing countries from accelerating national decarbonisation measures. Carbon markets, as important market instruments, offer a unique opportunity here to mobilise essential investments into cleaner technologies and help governments meet Net Zero targets.
Since its announcement in 2023, the Carbon Credit Trading Scheme (CCTS), under which the Compliance and the Voluntary mechanisms were included in June 2023 and December 2023, respectively, has remained one of the most eagerly anticipated developments. The government is expected to unveil targets for the compliance mechanism alongside methodologies for the Voluntary Carbon Market (VCM) component early this year, marking a crucial step in rolling out the scheme in April 2025.
While the two mechanisms will operate independently, India’s CCTS is expected to serve as a key policy instrument to channel international climate finance through the creation of financial incentives for industries to reduce greenhouse gas (GHG) emissions. This, in turn, is envisaged to support India’s climate goals by enabling investments in decarbonisation efforts and low-carbon transition, especially for hard-to-abate sectors.
Within the CCTS-compliance mechanism, there are two key components that will directly incentivise the flow of investment and capital towards low-carbon transition.
Firstly, the stringency of targets. A modeling study published by the Council on Energy, Environment, and Water (CEEW) in 2023 highlights that targets set by the government in CCTS-CM will provide a direct price signal for industries to make long-term decisions on decarbonisation. Currently, the CCTS-compliance mechanism, which is designed as a baseline-and-credit system with intensity-based targets (also referred to as the bottom-up approach), will provide emissions intensity targets for obligated entities (OEs) across the nine identified sectors, namely, aluminium, cement, chlor-alkali, fertilizer, iron and steel, pulp and paper, textile, petrochemical, and petro-refinery. The current scheme excludes the power sector, which accounts for nearly one-third of India’s GHG emissions. Meanwhile, the included sectors collectively account for 93 percent of all direct emissions from Indian industries (excluding the power sector).
Therefore, OEs identified within these industries will have to comply with their respective GHG emissions reduction targets. Market participation and activity will enable emission reductions wherever they are the most cost-effective. Hence, OEs will meet their targets either by internal reductions or by trading Carbon Credit Certificates (CCCs) with other OEs. This will enable financial transfers within the sectors. If lenient targets are set for a sector where cheaper alternatives are available and have a lower marginal abatement cost, this, in turn, will induce a large supply of credits from this sector to the others. Therefore, it underscores the importance of target setting in the mechanism, as the stringency of the targets would play a crucial role in determining the level and pace at which the industries participating in the scheme will pursue decarbonisation efforts. Thereby, the compliance scheme will directly incentivise the flow of investment and capital in the industry toward the adoption of low-carbon technologies.
Secondly, auctioning as a mechanism within the ETS scheme not only brings transparency and efficiency into the system but also serves as one of the key measures that can enable governments to generate revenue. This revenue can then be directed towards building renewable energy projects, energy efficiency programmes, and supporting sustainable livelihoods. Auctioning per se refers to a system where credits are not distributed as free allowances but are sold by the government through an auction process, enabling the participants to purchase the right to emit GHG gases up to a certain limit. While credits will not be auctioned initially in India as the scheme is introduced, where intensity-based targets at the entity level will be released by the government, in the long run, the scheme should transition toward absolute targets, and auctioning as a mechanism can be considered. This would not only be advantageous for generating revenue for the government but it would also not require setting specific individual sector-wise targets. It would instead focus on meeting an overall reduction target. For comparison, auctioning has been adopted by the EU-ETS and South Korean ETS, where it has been successful, and, as announced by China, will also be adopted in its national ETS.
Thirdly, the CCTS-VCM, which is an offset or project-based carbon market mechanism, is also expected to catalyse investments toward projects that will help reduce or remove carbon dioxide. In September 2024, the government identified a list of 10 priority sectors, including energy, industry, waste handling and disposal, agriculture, forestry, and transport for phase one. The initial phase is expected to kick off as early as April 2025. To illustrate, this will be an opportunity to attract private sector investments into technologies included in the sectors, such as green hydrogen production through electrolysis, RE with storage, offshore wind, green hydrogen production through biomass, compressed biogas, afforestation, biochar, etc. In phase two, CCTS-VCM will be extended to construction, fugitive emissions, solvent use, and Carbon Capture, Utilisation and Storage (CCUS). The scheme is expected to not only channel funds toward low-carbon technologies but also support innovative climate solutions that are currently in the nascent stage of development, such as CCUS.
Fourthly, through its domestic registry under CCTS-VCM, similar to Verra VCS and Gold Standard, the government would be able to generate revenue from transactions related to VCM project registrations. As a government-monitored scheme, the expectation among stakeholders is that of transparency and integrity within the VCM mechanism. Further, it will positively contribute to the ecosystem by providing consumers and project developers with more options.
Fifth, the inclusion of offsets into the compliance framework is important. If OEs are allowed to meet a certain percent of their targets through offsets, this, in turn, will give industries an additional incentive to invest in GHG reduction activities while simultaneously boosting demand in the CCTS-VCM mechanism. For the mechanism to be well established, the government will need to evaluate the potential percentage of inclusion of offsets within the compliance mechanism. Offsets, if utilised astutely, can provide flexibility and liquidity for OEs striving to meet stringent emissions reduction goals.
Historically, various countries have adopted the inclusion of offsets within the ETS. Initially, like India, Korea has had substantial experience with CDM projects and developing offset projects with a well-functioning voluntary market, which could provide room for entities to meet compliance obligations early on. Also, from EU and the K-ETS experience, it is prudent to understand the risks associated with uncertain demand and carbon pricing for offset credits and explore a phased limitation on offset usage, starting with higher limits for market flexibility and gradually decreasing them to encourage more direct emissions reductions. Additionally, while assessing the potential of offsets in the compliance system, the government will also have to decide where these offsets would come from and the nature of permitted offsets, ensuring environmental integrity (as seen in NZ ETS). These could come from the ICM-voluntary offset mechanism or from secondary private markets (eg Verra, Gold Standard etc). While offsets can promote liquidity and flexibility, only a defined proportion of compliance targets must be met through these credits. The government’s decisions on offset quotas will significantly impact market dynamics since offset quotas can be used as an instrument to regulate the market.
A critical first step for India will be to establish rigorous measurement, reporting, and verification systems. These are essential for ensuring the accuracy and legitimacy of emission reductions accomplished through an ETS and VCM mechanism. Additionally, exploring mechanisms like the stability reserves can help regulate allowance supply and promote market stability.
For India, the Carbon Credit Trading Scheme (CCTS) of the Indian Carbon Market will not only act as a tool to meet emission reduction goals, but it will also enable a pathway to sustainable development, economic transformation, and transition towards a low-carbon economy. To ensure the success of the policy instrument, meticulous analysis of the policy decisions is imperative. Historical experiences from international markets offer valuable insights that can contribute towards building a robust and well-functioning carbon market for India — one that not only fosters financial and investment opportunities but also helps the overall economy grow sustainably.
