The debate over India’s proposed Corporate Average Fuel Efficiency (CAFE) III norms comes at a crucial time for the global automobile industry as it transitions from internal combustion engines (ICE) to electrified powertrains. It also highlights India’s vulnerability to imported crude oil amid renewed geopolitical tensions. The framework India adopts today will influence investment, technology choices and energy security for decades.

CAFE III, compliance or transformation

The Power Ministry’s July 16 draft notification marks the third iteration of CAFE III after months of industry lobbying. While some manufacturers pushed for stricter norms, others sought flexibility. The proposal attempts a compromise, but the question remains whether it prioritises compliance over transformation.

CAFE norms set annual sales-weighted average fuel-efficiency targets for manufacturers’ passenger vehicle fleets rather than individual models. Introduced in the United States in 1975 after the 1973 Arab oil embargo, they aimed to reduce oil dependence and protect consumers from high fuel costs. The rules caused automakers to adopt smaller, more efficient vehicles. This also helped accelerate the rise of Japanese manufacturers.

From the 1990s, fuel-efficiency regulations gained a second purpose: reducing greenhouse-gas emissions. In the United States, the EPA’s Endangerment Finding brought greenhouse gases under the Clean Air Act, with later emissions standards aligned closely with CAFE rules. While technology-neutral, the rules encouraged innovation in hybrids and electric vehicles (EV). Ironically, the Obama administration’s $465 million Department of Energy loan to Tesla in 2010 helped accelerate an EV industry now dominated by China.

China’s experience is even more instructive. It introduced mandatory fuel-consumption standards in 2004, initially regulating individual vehicle models by weight rather than fleet averages. As car ownership surged, concerns over oil imports and urban air pollution grew. The standards tightened over time before China changed direction in 2018 with the introduction of its Dual Credit System.

Under this framework, manufacturers must meet both Corporate Average Fuel Consumption (CAFC) standards and New Energy Vehicle (NEV) credit requirements. Fuel-efficiency compliance alone is insufficient. Companies that fail to earn enough NEV credits through EV or plug-in hybrid production must purchase credits from those with surplus EV production, creating a market that rewards innovation and penalises delayed electrification. For example, in India, Maruti Suzuki could remain NEV credit-deficient by 18% despite having highly fuel-efficient ICE models if it had no EVs in its portfolio. It would need to buy credits from companies such as Tata Motors or Mahindra, which generate NEV credits through their EV portfolios. While CAFC credits can be banked, carried forward or transferred within corporate groups, NEV credits cannot be offset in the same way. The results are evident. According to the International Energy Agency’s Global EV Outlook 2026, China sold more than 13 million electric cars in 2025, accounting for almost 55% of new passenger vehicle sales. Comparable figures were about 27% in the European Union, nearly 10% in the U.S. and around 4% in India.

India’s own debate has centred on differences between Maruti Suzuki, Tata Motors and Mahindra & Mahindra. An earlier proposal effectively carved out lighter small cars from the full stringency of CAFE III. That exemption has since been removed. The current proposal seeks to reduce average emissions from around 113 gCO2/km to 77 gCO2/km by FY2031-32. On paper, that appears ambitious. Yet, the headline target tells only part of the story.

The cost of flexibility

The revised framework introduces several flexibility mechanisms that, taken together, substantially reduce its effective stringency.

The first is the Carbon Neutrality Factor, which awards compliance benefits for vehicles compatible with higher ethanol blends and other fuels. Yet, the government has informed Parliament that no decision has been taken to move beyond E20 blending (20% plant-based ethanol with 80% regular petrol). Manufacturers therefore receive compliance advantages for technologies whose long-term policy trajectory remains uncertain. Ethanol is also more expensive than petrol, and has lower energy density, and therefore delivers lower mileage — a fact belatedly acknowledged by the Centre after it drew severe criticism.

The second is the use of super credits. Battery EVs, plug-in hybrids, strong hybrids and flex-fuel vehicles receive additional weight in fleet calculations. While this encourages cleaner technologies, it also means that fewer actual low-emission vehicle sales are required to offset higher-emission models. Strong hybrids, which generally rely primarily on the ICE while using electric propulsion over relatively short distances and at lower speeds, also receive super-credit benefits despite offering only partial electrification.

The third mechanism is banking and trading of compliance credits. Manufacturers outperforming their targets can accumulate credits and sell them to others. In addition, the draft allows companies to buy credits directly from the Bureau of Energy Efficiency (BEE) at administratively fixed prices if deficits remain after trading. The BEE is therefore not a market exchange but effectively a seller of last resort.

In theory, this introduces efficiency into the system. In practice, it allows companies that are lagging to meet compliance requirements without upgrading their own technology. Moreover, the draft notification allows manufacturers to buy compliance credits from the BEE at ₹2,500 per gram of CO2/km in FY2028, rising to ₹4,500 by FY2032. By comparison, the Energy Conservation Act prescribes additional penalties of ₹25,000 or ₹50,000 per vehicle depending on the extent of non-compliance. Expressed in CAFE terms, the lower penalty threshold is broadly equivalent to a little over ₹5,000 per gram of CO2/km, implying that the proposed buyout price begins at less than half that level.

Finally, compliance is assessed over three-year blocks before shifting to two-year blocks, allowing manufacturers to average performance across multiple years rather than meeting targets annually. Therefore, delays in one year can be compensated in another.

The case of CNG

Taken together, these mechanisms significantly alter the stringency of these regulations. Which raises a fundamental question: What is the purpose of a regulation?

Regulation should shape markets rather than simply accommodate prevailing market preferences. India’s own experience with compressed natural gas (CNG) illustrates the point. Once policy support aligned with regulatory certainty, manufacturers rapidly introduced CNG variants. Regulation can create markets as much as respond to them.

To put this in perspective: manufacturers’ voluntary commitments already average nearly 20% EV share by 2030, with several original equipment manufacturers aiming for 30% or higher. In effect, the revised regulation attempts only half of what the industry itself has committed to. The timing also matters. India remains heavily dependent on imported crude, exposing the economy to geopolitical shocks, imported inflation and currency pressures. Strengthening fuel-efficiency standards is therefore not merely an environmental objective. It is an energy-security strategy, an industrial policy and a macroeconomic imperative.

These developments highlight the urgency and significance of revising India’s CAFE norms, as they offer an opportunity to address a macroeconomic vulnerability while helping meet India’s Glasgow commitment on energy efficiency.

India should seize this opportunity to position itself alongside the world’s leading automotive markets in the transition to low-carbon mobility.

Published - July 28, 2026 12:16 am IST