Offsets, Ambition and Risk: The Next Big Test for India’s Carbon Market 

The Bureau of Energy Efficiency (BEE) has published detailed guidelines for an Offset Mechanism in March 2025¹ to be used as a complement to the Carbon Credit Trading Scheme (CCTS). The guidelines state that only domestic offsets will be allowed. Offset projects must be located in India and registered with a domestic regulatory body. As we move closer to operationalising the CCTS, the way the Offset Mechanism interacts with the main Emissions Trading System (ETS) will affect the market’s integrity and liquidity. This will also determine how external systems like the European Union’s Carbon Border Adjustment Mechanism (EU CBAM) will impact the Indian industry. 

Why are offsets considered in an ETS architecture? 

The presence of an offsetting mechanism in an ETS brings flexibility to a compliance carbon reduction regime. By allowing purchase of offsets, an ETS system gives obligated entities (who are mandated to reduce emissions or pay penalties) the flexibility to tap potentially lower cost emission reduction units from sectors beyond those covered within the system. The use of offsets, in theory, allows the ETS to have stronger emission reduction targets to obligated entities, since there are lower cost options to meet targets now if emission reduction in normal business operations is not achieved.  

The CCTS and Offset Mechanism are currently seen as two distinct mechanisms, and offset credits are not interoperable with the Carbon Credit Certificates (CCCs) under the compliance mechanism. However, given potential price management benefits, increased ambition, and the ability to integrate larger number of stakeholders into the CCTS, future regulations could allow for fungibility of offset credits with CCCs. It is an important question for the regulators to consider given the popularity of voluntary credits and the interests of various stakeholders to signal net-zero and neutrality in their operations. It also becomes critical from the perspective of the agreed Article 6 rules under the Paris Agreement. 

The allowance of offsets in ETS is, however, not risk-free. The most notable concern is whether the use of offsets undermines the primary intention of an ETS to drive decarbonisation in the target sectors (which are often high-emitting and have hard-to-abate processes). The ability to use offsets to meet a large part of the obligated emission reduction disincentivises deep emission cuts as it becomes easier to buy cheaper offsets than to invest in process-oriented decarbonisation. Ultimately, it has the effect of driving down the carbon price of the regime.  

Experiences from around the world 

Carbon pricing regimes in Columbia, South Africa, and South Korea have allowed conditional use of offsets to meet compliance targets within ETS and carbon tax regimes. A certain quota (quantitatively defined as a percentage of the obligated emission reduction) of the total emission reduction target can be met by an obligated entity by purchasing offsets. Over time, this quota has evolved in subsequent stages to increase ambition and decarbonise the economy further. The experiences and learnings are meaningful for India to learn from.  

Colombia built its 2016 carbon tax around a generous offset provision: companies could initially offset up to 100 percent of their tax liability by surrendering eligible domestic carbon credits, primarily ‘avoided deforestation’ credits. Investigations found widespread baseline inflation in such offset projects, generating poor-quality credits. The government has since ratcheted the offset limit down from 100 percent to 50 percent and proposed a further cut to 30 percent. South Korea, in its early ETS phases, also allowed generous use of domestic and international offsets and experienced price falls. Subsequent reforms tightened the offset quota and introduced a market stability reserve. South Africa took a conservative approach² to avoid price/integrity issues. Its carbon tax (in Phase 1) allows offsets to cover only 5-10 percent of an entity’s liability (rising modestly in Phase 2) and requires domestic projects to use internationally recognised standards. The system screens for additionality and no-double-counting.   

The lesson drawn across these three cases, supported in the broader academic literature on carbon pricing regime design, is consistent: high offset quotas tend to reduce allowance prices, sometimes sharply, unless regulators simultaneously tighten the underlying cap or introduce active price management tools³.  

Design considerations for India given CBAM exposure 

The effect of offsets on the domestic carbon price (the effect price of the CCC) is critical to India’s positioning in an increasingly global outlook on carbon pricing. The impact of the EU CBAM has been heavily debated and even negotiated at the top levels of both, the Indian and the EU Governments.  

A simple thought experiment suggests how offset allowances could affect the carbon price of the ETS regime. Given that most offsets are available at a lower marginal cost, allowing a 10 percent offset quota can reduce compliance costs for obligated entities without offset prices determining the marginal carbon price of the entire regime. Allowing 30 percent begins to shift the incentives away from internal abatement toward offsets. The carbon price starts to converge toward the offset cost rather than the industrial abatement cost. At 60 percent, the price signal is effectively pinned by the offset market and not by the cost of transforming industrial installations⁴.  

Under EU CBAM rules, the carbon cost that an Indian exporter can deduct from its border adjustment liability is a ‘carbon price effectively paid in the country of origin’.⁵ The EU’s interpretation of this provision points to ETS allowance prices or carbon taxes. If India’s CCTS allowance price is suppressed because offset supply is abundant and quotas are generous, that price may be too low to be credibly recognised as a domestic carbon price-equivalent under CBAM. Indian exporters risk facing the full CBAM levy at the EU border. 

The CCTS x Offset integration requires guardrails embedded into market design 

A well-designed CCTS x Offset integration can avoid this outcome. It requires a low offset of no more than 10-15 percent, stringent baselines for Nature-based Solutions projects comparable with international voluntary market standards, a market stability reserve to guard against oversupply, and a clear regulatory mechanism to tighten both caps and offset limits over time. Used this way, high-integrity offsets can provide liquidity, mobilise finance for rural and forest communities, and improve the political durability of the market without hollowing out the price signal. 

Offsets used without guardrails risk turning India’s emerging carbon price too weak to signal credible industrial decarbonisation precisely now when that signal needs to be robust enough to count at the EU border. 

Authors: 

Kundan Burnwal, Deputy Project Director, RECAP4NDC, GIZ India 

Saurab Babu, Climate Change Advisor, RECAP4NDC, GIZ India 

The views expressed in this article are personal and do not represent those of the organisation.