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 Climate Change

Finance
Published on: Feb. 14, 2020, 8 p.m.
Green Bonds can be a strong pillar
  • Green bonds are in the top three in terms of sustainability

By Neha Kumar. The author is India Programme Manager, Climate Bonds Initiative

For India, reshaping its growth trajectory to low carbon and climate-resilient pathways is more a lifeline question than a lifestyle one. Multiple challenges that India faces today – rising hazardous pollution, agrarian distress, rapid and unsustainable urbanisation, frequent and severe droughts and floods, depleting jobs and livelihoods, widening inequality – are fault-lines that have appeared within a reasonably high economic growth trajectory that India has maintained for nearly three decades. Climate change threatens to widen these fault-lines and cost India’s economy 2.8 per cent of its GDP every year by 2050. None of this, however, has been able to make climate change and environmental sustainability central to political discourse or economic policy thinking. 

Add to this the current economic slowdown India is reeling under. It is deep and without a long-term remedial strategy, it is possible that we will keep hovering on the lower bounds of 5-7 per cent growth. Getting us back up to a growth rate in the region of 7 per cent, sustaining it, creating enough jobs and delivering a development transformation that maximises environmental and social gains presents the most defining challenge for India today. 

Climate proofing our economy will cover everything from reducing our dependence on coal to arresting the depleting water table to making our cities liveable and preventing shocks to the food system. It is also pretty well understood that this will require shifting away from business as usual, altering fundamentally the way we produce and consume, and mobilising and deploying capital at scale into sustainable economic activities. Conservative estimates suggest that we will need at least $2.3 trillion to meet our climate targets alone through to 2030. 

It is abundantly clear that public finance alone won’t be sufficient, given the asymmetry between the investments required and capital available. Capital mobilisation from the market and greater private sector participation will thus need to be a more active part of the mix. And, yet the approach to achieving this remains piecemeal without a clear understanding of how different sectors of the Indian economy will change or need to change and how the big ‘brown to green’ transition will be financed. 

The Renewable Energy (RE) sector which is at the forefront of this transition has become more competitive than coal in less than a decade. And, even though its growth is mainly powered by private capital, the high cost of capital still remains a big barrier in accelerating the required shift to achieving our target of 175 GW of installed RE capacity by 2022. The shift in mobility technology and solutions is happening fast, and reaching price parity for EVs by 2024 is within the realm of achievement. Still, the financing options currently available do not match the ambition of increasing EV penetration to the intended 30 per cent of all auto sales by 2030. And these are the vanguard ‘green sectors’ which have been benefiting from the ambitious policy thrust. 

Agriculture, on which 50 per cent of Indians depend directly or indirectly, stands to be severely hit by climate impacts. The Economic Survey of India 2018 estimated that climate change could lower farm incomes by 20-25 per cent. The growth rate in the sector has plummeted to 2.7 per cent from 6.3 per cent since 2016. While a host of reforms are needed to unshackle productivity and incomes in the sector from market vagaries, investing in climate-resilient activities like natural farming that have been shown to enhance soil organic matter are key to not only enhancing food security but also for securing the livelihoods of farmers. 

While cities themselves can turn into the fulcrum of green growth with commensurate investments in green buildings, waste and water management, pollution control, and infrastructure that can withstand extreme weather events, there is a lack of clarity on how the allocations under the AMRUT and Smart City Mission can be leveraged and private capital be channelled at scale for sustainable urbanisation.

An IFC report on climate investment opportunities in South Asia gives the following sector break up for India:

The recent announcement by the ministry of finance to set up a task force to roll out Rs100 lakh crore infrastructure projects by 2025 can be the crucible for large scale green investment. The terms of reference include identifying a technically feasible, financially and economically viable project pipeline. The task force is also mandated to identify the right source of capital to finance these projects. Including green screening criteria is a logical and critical step which is currently missing. This would be able to identify green investment opportunities within this basket and could be a definite way to attract foreign capital chasing these projects in emerging economies like ours. This would also help the domestic financing architecture respond appropriately to the risks emanating from climate challenges and help design an investment strategy fit for the new economy.

Current sources of financing – mainly loans raised from banks and non-banking financial companies – face inherent constraints where a mismatch between the long-term nature of infrastructure projects and short-term bank liabilities restricts the flow of capital required for such investments. The continuing stress in the banking and shadow banking sector compounds the problem.

Enter green bonds:

These are fixed-income debt instruments which utilise the advantages of regular bonds like a fixed interest rate (bank lending is structured as a floating rate linked to banks’ cost of funds), long tenor, tradability, larger ticket size, access to a much more diversified pool of investors in the debt capital markets – and – add the green as a bonus feature. It basically means earmarking the use of proceeds for environmentally-sound projects. This lends a high degree of transparency. In addition, issuers can raise capital both in domestic and international markets via green bonds.

India tapped the fast-growing international green bond market in 2015 and since then has issued $9.01 billion worth of green bonds. Among the emerging economies, China leads by a wide margin with 10 times the volume of issuances as that of India and sits alongside the US and France amongst the top three in the world. India is not a bad tally but given the potential, it is still a highly under-tapped market for international green investors chasing bankable projects. The sector-wise break-up shows potential for diversification.

In developed economies, green bonds are being accessed by national governments, corporates, banks, mortgage providers, airports and real estate. There is growing diversification in the type of issuers and sectors. India’s green bond issuances have been driven by private and public sector corporates and financial institutions.

India’s green bond market is nascent, and it mirrors some of the dominating international trends. Oversubscription by two to three times and upsizing of green bonds is a normal feature. It reflects high investor demand and widens that pool for the issuers. Indian issuers have witnessed between 14 and 24 per cent investments from dedicated green funds. This is a new set of investors which would only subscribe to a bond because of its green features.

Treasuries of issuers commonly say that investor diversification helps them price the deal better. In the EXIM Bank issue, which was the first dollar-denominated green bond from India (2015), for example, the oversubscription was 3.2 times of which 0.8 per cent was dedicated green funds which helped EXIM tighten the price.

EXIM was also able to bring the coupon rate down by 20 basis points (a basis point is 1/100th of a percentage point). The frequency and possibility of tightening the coupon rate, thereby lowering the cost of funds, as opposed to regular bonds is much higher for green bonds, say experts. Investors tend to attribute a lower cost of capital also because the internal risk management and governance processes of green projects are more comprehensive and transparent as required by the green bonds framework that issuers have to set up. This transparency feature can be effectively used to build confidence among investors.

However, these benefits accrue more to labelled or certified green bonds. An analysis by the National Bureau of Economic Research, US, (2018) showed that there is a positive correlation between certification and the financial benefits of green bonds. The sample, limited to green municipal bonds in the US, showed yields were up to 20 basis points lower for certified green bonds than regular bonds with similar characteristics and timing. As the green bond market grows, there will be more data to analyse and empirically establish many such advantages.

India’s external debt to GDP ratio is low, hence conducive to raising international capital by Indian corporates and state-backed entities in the international green bond market more aggressively. The provision for sovereign borrowing in foreign currencies outlined in the budget should, however, be carefully thought through as has been pointed out by many prominent economists, and appropriately acknowledged by the government. One way to tap foreign savings will be to, of course, relax the foreign portfolio investor norms for investment in government rupee bonds as this would foster the local bond markets. Another possible option is this sovereign masala bond (rupee-denominated bond issued offshore). In both cases, green criteria will help attract better terms and prove to be a tremendous market-making step.

India’s sovereign credit rating of BAA2, however, means that many green bonds need credit enhancement to attract international investors. Partial or full guarantees by multilateral and national development banks and organisations such as the IIFCL have helped in improving the credit ratings of corporate issuers and will continue to play a role. But, these need to be made more widely accessible and affordable to help more issuers come to the market. Here again, swift implementation of a “dedicated credit enhancement institution for infrastructure” announced by the finance minister in this year’s budget, will go a long way.

Supportive regulations, like the SEBI guidelines on green bonds disclosure, exist. Broader regulations that could further deepen the Indian bond markets are also in place. These would help in accessing the large domestic savings for infrastructure projects, facilitate market access for the private sector, lengthen bond tenors and help reduce the cost of financing.

States regularly raise bonds. They could also issue green bonds as sub-sovereign debt in the domestic market, of course within the fiscal framework. It will help them derive the benefits of raising money at better terms as also drive the green bond market itself. In fact, adaptation and resilience focussed investments will need state and state-backed financial institutions to be in the driving seat. Municipalities and other city development authorities have been hesitant in accessing the market mainly because of management and governance issues, dependence on state grants and under-performance on revenue generation. Much of the infrastructure they commission and services they provide fall in the green category, but none of the issuances that have recently happened is labelled green – mainly because of lack of awareness.

The Global Green Finance Index 3 – a survey of quality and depth of green finance offerings across 110 international financial centres, published in March this year – suggests that among the many green finance instruments, green bonds are among the top three in terms of impact on sustainability. A good measure of innovation is happening in the Indian marketplace to access green financing even for smaller assets and projects that can’t access financing on a standalone basis through bonds. India can mobilise a whole array of financial instruments like aggregation and green securitisation, catalytic financing mechanisms like blended finance (where public money is used to crowd in private capital), green loans, and impact investing to help finance its development.

Greening India’s development is one of the key strategies to mitigating the risks to its growth. This green new deal – that promises environmentally and socially just transitions – will need concomitant financing mechanisms that combine different sources of capital and drive clean growth in existing and new industries. From defining what is green to designing smart policies and incentives to make green investment increasingly affordable will further enable corporates – big and small – and financial investors to play a more enduring role in the country’s development transformation. India needs to amplify the opportunities both in the domestic and international markets to shore up the capital needed to deliver the new economy.


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