Tamil Nadu and Gujarat will soon have India’s first domestic emissions trading scheme (ETS), which will be tied to air pollution. It will be implemented under a cap on air pollutants set by the respective state pollution control boards as a pilot for the rest of the country for six months.

Jairam Ramesh, minister of state for environment and forests, described the plan as “a big innovation...in market-friendly systems of implementing environmental laws”.

The scheme works thus: A ceiling on emissions of a certain pollutant is set, based on its desired concentration in the atmosphere. The government then issues or auctions free permits to industrial units in accordance with the amount of pollutant they are allowed to emit. If the plant exceeds the level, it has to buy these permits from others and vice-versa.

“I have said before the problem is not in regulations but in regulators. That’s where the harassment comes,” Ramesh said in an interview on Wednesday. “So I have got Esther Duflo, who is called the most brilliant economist in the world today. She and her team from MIT (the Massachusetts Institute of Technology) prepared a report for us on creating an emissions trading system and we will start with this in Tamil Nadu and Gujarat and later extend it to the rest of the country,” Ramesh said.

The report that Ramesh referred to was written by Duflo, Michael Greenstone and Nicholas Ryan of MIT and Rohini Pande, Harvard Kennedy School, Harvard University.

The limits on the industrial pollutants will be set by the states themselves in consultation with the Central Pollution Control Board. Akin to the carbon market, the cap will help in lowering pollution levels at lower overall costs of compliance.

This will allow the regulator to set a cap on the aggregate level of pollution permitted, and then allow a self-regulating system to ensure that pollution does not exceed this cap. A system of credits that can be traded is most commonly used for industrial units falling above or below pollution limits.

A programme covering oxides of sulphur and nitrogen in the US did work but “this kind of ETS presupposes lots of things”, said Anumita Roychowdhury, associate director at activist group Centre for Science and Environment.

“It will need a very transparent mechanism, robust monitoring and will have to be quantifiable, for which a lot of institutional preparedness will be required,” she added. “Also, it will apply more to the organized sector. If these emissions are in the unorganized sector, it will be very hard to monitor. So it is limited. Plus, it might also need third-party checks.”

Some legal amendments may be required, said an environment lawyer, who did not want to be identified.

“For instance, for the energy efficiency market, the ECA (Energy Conservation Act) had to be (changed), which was done by Parliament,” he added.

This won’t be the first market-based regulatory instrument in the environmental sector in India. Under the national mission on energy efficiency, India will soon have the “Perform, Achieve and Trade” mechanism for energy efficiency, which will cover facilities that account for more than 50% of the fossil fuel used in India, and help reduce carbon dioxide emissions by 25 million tonnes per year by 2014-15.

Varad Pande, officer on special duty to the minister, said that Tamil Nadu was chosen because it has been progressive in its monitoring of air pollution. The state at present has real-time online monitoring of pollution loads at the industrial unit level, which will be scaled up and rolled out across the state.

“Gujarat was chosen because they also have shown interest in innovations in controlling pollution,” he said. “Right now, they are studying the impact of third-party monitors on pollution loads.”

There will be a meeting of the pollution control boards and the ministry on 19 January in Delhi to discuss the next steps for the implementation of the ETS, what the states will require and how the Centre can help. The framework will be set up in the first half of 2011 and implemented in the second, Pande said.