Last month, the Prime Minister's Office held a review of India's position on the Kyoto Protocol, which the Centre signed five years ago. Developing countries have been given a grace period, until 2012, before they undertake any commitments under the treaty. But, correctly, the government wants to get into the act now, and formulate its policy well before it is forced to make any cuts in carbon emissions, which may prove detrimental to the economy. At the G8 Summit this month, pressure will be brought to bear on China and India - particularly but not solely - by President Bush to fall in line. The American president has repeatedly cited the concessions to the Asian giants as one of his main reasons for not signing the Protocol.

Recently, European Union Foreign Ministers too urged Asian countries to join the fight against global warming. At a meeting in Hamburg, the Chinese minister countered this plea by arguing that the protection of the environment had to be balanced by recognising the right to develop, so that its citizens could look forward to better living standards in the future. He elaborated that China would welcome the transfer of clean technologies, which would allow it to develop without increasing emissions while doing so. The entire question of what these technologies will cost, and who will bear this burden, has been left hanging in the air.

The Ministry of Environment and Forests here knows only too well that the Kyoto Protocol is both a challenge as well as an opportunity. It is at present concentrating on the opportunity, because India does not have to reduce its emissions for another five years, and MoEF wants to take advantage of the transfer mechanisms that exist till then. Under the Protocol's Clean Development Mechanism (CDM), it is possible for industrial countries or companies based there to absorb their emissions by paying developing countries to introduce clean technologies that absorb the equivalent amount of carbon.

There are moral objections to this arrangement, by which polluters do not pay the true ecological and economic cost of degrading the environment but are given a cheap way out by buying offsets in poor countries. Typically, a power utility in Europe or North America can pay a developing country to launch an afforestation project which will sequester a certain amount of carbon and thereby let it off the hook. It would be more equitable for a company to pay a carbon tax - the Worldwatch Institute in Washington years ago proposed $50 per tonne of carbon. This tax would incidentally raise sufficient revenue to take care of virtually all the development programmes that countries need to pull them out of poverty. It would also force emerging countries like China, India and Brazil to get their act together and reduce their emissions, also after a grace period.

India has been harping on one theme: that it is accepting "common but differentiated responsibility" for climate change, which is right. But this should not blind the country to the urgent need to cut down on the profligate use of fossil fuels. It is estimated that between one fifth and one quarter of power is lost in transmission and distribution, which is equivalent to the capacity of a few sizeable power stations. India is also wrongly concentrating on road transport for goods, which is wasteful and polluting. Rail is a far better option, especially for a country with one of the biggest networks in the world.

As it happens, the International Institute for Environment & Development (IIED) in London, which was the brainchild of the late economist, Barbara Ward, one of the leading lights of the sustainable development movement, published studies last year which have questioned the benefits of CDM to developing countries. As many as 50 of the least developed countries have not even heard of carbon credits. Only those with capacity to propose and implement projects, like the three big countries already referred to, can take advantage of these schemes.

Typically, the mechanism has operated for industrial or technological solutions. There are two main avenues - one is to generate energy from landfills and the other is to reduce the emissions of the greenhouse gas, hydrochlorofluorocarbon (HFC). Urban garbage dumping sites do contain methane which in theory could be burnt to produce power. However, the experience in India with such waste-to-energy projects has been abysmal because garbage in cities here contains far less packaging material than in the West. It is mainly kitchen waste, which is wet and does not burn easily.

According to the Carbon Finance Unit of the World Bank, nearly 60 per cent of carbon offsets was in HFC projects and the average volume was 1.9 million tonnes of carbon dioxide equivalent. Smaller projects would be far more beneficial because of their greater employment potential, but their transaction costs are much higher and are therefore avoided as a rule. The Bank's annual survey shows that there are very few projects anywhere in the world which tackle less than 50,000 tonnes of carbon dioxide equivalent.

There are problems in the very operation of CDM. For one thing, rather like outsourcing, there is always the danger that another developing country with less rigorous environmental standards may undercut the price that one offers for carbon credits. The other, as the Centre for Science and Environment has been pointing out for years - it published Green Politics in 1999 - is that when India and other developing countries come under the Kyoto Protocol after 2012, the costs of offsetting our carbon emissions will be much higher than they are now. Who will bear these costs? And this has a direct bearing on living standards. No wonder that President Bush once justified his refusal to sign the Protocol by asserting that American lifestyles could not be compromised.

The UN Intergovernmental Panel on Climate Change, which just put out its fourth assessment report, cites a maximum possible increase of 3 degrees Centigrade by the end of the century. With this rise in temperatures, the implicit cost of reducing a tonne of carbon dioxide equivalent will be in the $20-$80 range. This gives us an idea of the costs of living within the capacity of the earth to contain emissions in future. By selling our rights at present and earning some dollars and euros in the process, we are in fact postponing paying this bill and bartering the future of our children and our children's children.

The IIED believes that there are better opportunities with the voluntary market for carbon offsets, which exist outside the Kyoto Protocol. The motives of these sellers and buyers are different. Compliance is not the main consideration on the part of buyers; rather, it is desire to do something to combat global warming to assuage guilt or to improve their image. The lowest price may not be the major factor and there is a much bigger range of projects, which characteristically cannot compete in the CDM market.

The market is admittedly much smaller than CDM: it consisted of just six million tonnes of carbon offsets in 2005, as against 346 tonnes in CDM that year. And there are only 63 retailers worldwide, mainly in the US and Europe. However, the IIED estimates that in the next few years, the voluntary carbon market will account for 500 million tonnes annually.

At the same time, the standards in the voluntary market are far from uniform. Reductions of carbon dioxide equivalent involve complicated calculations of future emissions that will be offset by undertaking the project at hand. Such procedures have not been established rigorously. The CDM Gold Standard and the Emissions Trading Association have tried to introduce a set of regulations which would govern the voluntary market. However, if more exacting standards are imposed, this would exclude smaller projects in less developed countries.

The IIED and New Economics Foundation are launching a new type of offset programme called Mitigation-Adaptation or Mit-Ad, which seeks to offer both emission reduction (mitigation) or adaptation measures (actions). For example, afforestation in a coastal area would serve both to mitigate the impact of climate change by absorbing carbon dioxide and serve to help adapt to ocean level rise, an outcome of global warming. These 'double-whammies' may actually command a premium, but will have to carefully calibrated to serve the voluntary carbon market.