‘Mainstreaming climate change and sustainability initiatives require adequate investment growth and funding. As India inches closer to sustainable development target deadlines, does it have the requisite green finance mechanisms to attain the same?’ 

Introduction

Green finance is the umbrella term for the increase in financial flow (from banking, insurance, and investment) from public/private sectors to green and sustainable development priorities. It aims to achieve a balance between economic returns and environmental benefits through greater capital allocation to sustainable measures. Financial arrangements introduced to execute the vision of green financing include the following: energy production from renewable sources (solar, hydro, wind), cleaner transportation, energy-efficient building, waste management, etc. Financial instruments and institutions like green bonds, green banks, renewable energy-based PSUs, green funds, etc. have come up to facilitate these arrangements.

India’s climate change commitments and goals were applauded in the recently held ‘Leaders’ Summit on Climate’. However, a much different picture emerged when reports of persistent shortages in India’s green finances surfaced. These stem from major challenges that still plague the development of a robust green financing system. Remedying these barriers will require necessary policy interventions in the finance sector, both from private and public parties. In light of this, the article covers the status of green finance in India. After presenting a contextual setting of green financing in India, the article addresses these challenges and proposes policy solutions in line with international best practices. 

Contextual Setting

As with several countries, India too is facing the brunt of severe climatic conditions. Flash floods, droughts, untimely rains, heat waves, etc. have exacerbated in recent years, breaking several records. At the same time, India has declared ambitious plans for economic development, including the widely-known plan of achieving a US $5 trillion economy by 2024. To that end, India requires a well-developed layout to balance its economic plans with future sustainability goals. Climate change effects have the potential to hinder economic progress. As of 2021, a study has indicated that global warming has caused the Indian economy to be 31% smaller than it should be. If requisite steps are not taken to address these changes, it could stall economic growth severely.

The Reserve Bank of India (‘RBI’) noted the impact of climate change and green finance as early as 2007. Since then, the RBI has taken a slew of actions to generate public awareness and encourage green finance initiatives in the country. Securities and Exchange Board of India (‘SEBI’) has also contributed by issuing green bonds since 2017. With an emphasis on introducing electric cars in India, the State Bank of India (‘SBI’) has introduced green car loans with lower interest rates and longer repayment windows. Even more, the Ministry of Corporate Affairs has mandated reporting progress on Corporate Social Responsibility (‘CSR’) as per the Companies Act, 2013. However, not all have been favorable in terms of executing and innovating green finance schemes. Several challenges still stall progress in the sector, as detailed below.

Taxonomy of ‘Green’

A recurring challenge that countries, investors, and regulatory authorities face is to define the boundaries and details of what projects and developments count as ‘green’. ‘Green taxonomy’ includes identifying and classifying green projects and assets. Having a robust taxonomy for what qualifies as ‘green’ helps market players to weigh risks and manage their strategic purposes to achieve sustainable goals. There is, however, a lack of clarity on what assets and projects qualify as ‘green’ which poses a barrier to scaling up green finance. Hence, it becomes the first and foremost challenge to be dealt with when it comes to ensuring successful green financing.

According to SEBI, funds are classified as ‘green’ only if the funds raised are utilized for eight broad categories that include renewable energy, clean transportation, sustainable water management, biodiversity conservation, etc. This definition still has a long way to go in defining the boundaries and intricacies of ‘green’. Compared to international practices in green taxonomy, India has not mobilized resources the way European Union (EU) has in formatting the EU Green Bond Standard. It takes a comprehensive approach with three requirements: the project should substantially contribute to one of the six environmental objectives; it should not do any significant harm to the other five objectives; it should comply with minimum standards. The six objectives include climate change mitigation, climate change adaptation, sustainable use of water and marine resources, transition to a circular economy, waste prevention and recycling, pollution prevention and control, and protection of healthy ecosystems.

The success of this regulation lies in the fact that while projects need to satisfy only one objective, they cannot do so while ignoring the rest. This ensures that the projects maintain a balance towards all the six broad objectives. An approach based on EU’s could be adopted in India, meshing it with the SEBI guidelines. Since the SEBI guidelines are already broad and India-specific, the second requirement as stated in the EU Green Bond Standard could be adopted to ensure that projects do not cause harm to other environmental factors while satisfying only one. 

Green Bonds

Green bonds are financial instruments that channel investments towards projects with environmental and sustainability benefits. Many such bonds can be tax-exempt and have excellent AAA quality credit ratings, making them highly desirable. Proceeds from such bonds have been used to finance sustainable and renewable energy programs all across the world. Several countries, including India, have participated in this green bond market, using it to finance some significant programs with the help of the World Bank. Despite this, India’s green bonds issuance has not reached its full potential.

To further encourage the development of green bonds, municipalities and cities can be tapped to issue them. In Norway, the city of Oslo has issued the biggest green bond of the country, along with several regional municipalities contributing to other bonds. Currently, the weight of green bonds’ issuance lies on the central government and state banks. India could open up green bond issuance through these local bodies that will then channel these funds for projects in their respective regions. Diversifying the bond issuers will multiply the number of green bonds and allow targeted regional development. This decentralization will also provide investors with a wider set of green bonds to choose and invest in.

Aggregation of Small-Scale Projects

Often green bonds can be used for small-scale projects involving high transaction costs. These costs can have the effect of deterring investors from investing in such small-scale projects. To overcome this barrier, some countries have come up with asset-backed securitization that aggregates several small projects together. This aggregation scales up the finances of a large group of projects and allows them to lower costs due to economies of scale. The Clean Technology Fund (CTF) works with World Bank, Asian Development Bank, Inter-American Development Bank, etc. on such aggregation projects. CTF, along with IBD, has used this mechanism to create a $50 million fund of aggregated small-scale projects.

Given the vast number of green projects in the works in India, such a mechanism can be put in place. A government entity, perhaps like India Infrastructure Finance Company Ltd (IIFCL) or Solar Energy Corporation of India (SECI), can work with the national/global banks to aggregate such small-scale projects into large-scale ones. Considering the multiple government corporations in India that are focused on environmental measures (such as Rajasthan Renewable Energy Corporation, Andhra Pradesh Solar Power Corporation Private Limited, National Hydroelectric Power Corporation, etc.) they can be drawn into a series of aggregation of projects for green bond financing. It will, of course, be important to ensure that these corporations have the financial viability and required workforce to undertake such operations. This will be imperative to ensure that capable functioning helps attain economies of scale and subsequently lowers the cost.

Tax Incentives

As outlined above as well, green bonds often involve high transaction costs. This creates a barrier for interested potential investors. Thus, tax exemptions are usually the preferred way to incentivize green bonds in the market. India has followed this convention and granted tax exemptions on green bonds issued by Indian Renewable Energy Development Agency Limited (IREDA) in 2016. But the scope of tax incentives could still be improved using tax credits. Tax credits allow offsetting a certain portion of the tax liability of the investor. This practice was first adopted by the US government’s Clean Renewable Energy Bonds (CREBs) and Qualified Energy Conservation Bonds (QECBs) program.

Offsetting tax liability would be beneficial to Indian corporations as well, saving them the hassle of taxes and accountancy costs that often constitute a chunk of their expenditure and time. This tax credit facility could be practiced in India to provide investors with a massive incentive to invest in green energy. If tax incentives and adequate capital enter the green bond market, it would enlarge the reach of green financing by bolstering demand from investors. This could be part of the corporations’ annual CSR, enabling them to demonstrate a healthy outlook towards the society and environment while also saving tax costs.

Credit Guarantee and Enhancement

Green bonds can be perceived to be high-risk bonds, owing to the new position they hold in the market. As such, green bonds do not hold the financial credit profile of bonds with regular risk returns. This can prove to be discouraging for many investors. Enhancing the credit guarantees of green bonds is, thus, necessary to draw more investors into financing green projects. 

India has already seen one such example of credit enhancement. IIFCL partially guaranteed ReNew’s bond issue, increasing its credit rating from BBB to AA+. Government intervention in the form of guarantees has a significant impact on the credit rating since it involves lower risk and higher trust, as seen in the IIFCL’s example. China has encouraged local governments to provide partial guarantees, demonstrating the deepening of credit guarantee measures. While some municipalities and local bodies might find it difficult to issue bonds, they can nevertheless provide partial guarantees for green projects issued by other entities. Such projects could help raise capital for infrastructural growth (solar panels, hydro projects, waste management), allowing local bodies to bring sustainable economic growth to their respective regions without waiting for central/state allocation of resources. These credit enhancement measures are necessary to elevate small or risky green bonds into higher credit-rated bonds that investors would take a chance with.

Way Forward

While India has made commendable progress in achieving some of the climate goals, the larger challenges to sustaining and enhancing green finance remain. Policy initiatives, in line with international best practices, provide a window into possible solutions that have been tried and tested the world over. Of course, the regional differences in India mean that policies cannot be adopted without molding them as per our specific requirements. With climate change becoming a pressing concern with each passing day, these green finance instruments and institutions stand to ensure that climate goals and economic ambitions can be balanced and satisfied.

Siddhant Choudhury is a second-year undergraduate law student at the National Law School of India University, Bangalore. (The opinions expressed in this publication are those of the author/s. They do not purport to reflect the opinions or views of The Policy Observer or our members.)

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