In the Union budget, the government announced its intention to promote green bonds to support investments in climate-friendly projects. This is a timely move as India urgently needs to scale up its funding to meet its climate obligations and finance low carbon development.
The latest estimates released by the Ministry of Finance (2018) project that the cumulative cost of India’s current Nationally Determined Contributions (NDCs) is around $3.5 trillion. According to available statistics, no more than 10% of this sum will probably come from multilateral and international channels. The rest must be mobilized through the national financial system. But green finance remains scarce in India and small-scale, even as India emerges as a major player in the green bond market after the United States and China.
The green finance landscape in India has three notable features. First, the cost of green capital is higher due to its unconventional nature, the risks involved and the lack of a supportive regulatory framework. Second, there is a lack of solid and verifiable green financial products in the market. Those that do exist are biased towards debt instruments that only partially hedge the risk and scale of long-term financing. Finally, there is a predominance of projects to add renewable energy capacity, with small allowances for energy efficiency. Difficult sectors such as infrastructure, industry, resource efficiency and transport have few projects.
Although international agreements require climate finance to be concessional or grant-based, private finance has no such assurance. The cost of green finance tends to be higher than normal and acts as a deterrent. The country needs a favorable governance framework to encourage and mainstream green finance. Sound policy guidelines will help financial institutions understand their responsibilities in greening the financial sector. Mandating a share of loans for green projects can mitigate risk and help improve the rate of return.
At the institutional level, one could start by agreeing on a universally accepted definition of green finance and disclosure standards for companies seeking investment. To overcome multiple definitions, disclosures and reporting practices, the green finance taxonomy can be linked to NDC goals. If the financial sector regulator adopts them as a benchmark for green loans, there can be a positive impact on overall costs and access to finance. In due course, a standardized green taxonomy could be developed to align with international practices.
Disclosure by companies of the environmental impact of their actions is necessary to build investor confidence. SEBI requires the 1,000 largest publicly traded companies by market capitalization to file commercial responsibility reports. Establishing disclosure standards in these reports and enforcing them as part of a national reporting system could help eliminate information asymmetry for investors and reduce the cost of foreign capital.
The availability of verifiable good green products for investment, banking and insurance is necessary for the growth of green finance. Currently, green bonds dominate the market. However, there is a need to develop equity-based instruments complemented by policy instruments such as blended finance or results-based financing.
A major obstacle for the private sector is the perception of high risk and the additional costs involved in developing these products. Risk mitigation mechanisms are needed. Public funds backed by international finance can be used to provide risk mitigation support in the form of first-loss guarantees in debt and equity investments, hedge funds for external borrowing, subsidized insurance for climate-resilient assets, in addition to traditional grants and concessional loans.
The renewable energy sector today constitutes the largest share of green finance. Other sectors traditionally perceived as financially unsustainable, such as infrastructure, manufacturing, transport and the circular economy, need a similar scale of funding. Sectoral targets with monitoring provisions and a system of incentives/disincentives can encourage capital flows as well as innovations. The creation of special funds to cover the risks involved and the imposition of green lending standards by the central bank could be other ways to improve the viability of these investments.
Mobilizing finance for green purposes requires a combination of political support, regulations and risk mitigation instruments. Its success will be determined by the extent to which we are able to use funds and public policies strategically to close the sustainability gap and increase investment.
The author is a Distinguished Fellow of the Institute of Energy and Resources and former Special Secretary of MoEFCC
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