India is set to issue sovereign green bonds but it needs more work

Given the challenges associated with accessing finance for climate action, India is issuing a new category of financial instruments. This year, the budget has made a proposal for issuing sovereign green bonds as part of the government’s overall market borrowings.

While the sovereign green bond issuance can send a signal on the country’s commitment to low-carbon growth strategies, it can push the financial market towards decarbonisation. Poland and France, for instance, have raised funds through the issuance of sovereign green bonds. India, too, has jumped on the bandwagon to address the finance gap.

The announcement has created exuberance among the country’s green evangelists and climate-conscious investors; this celebration warrants a need to exercise caution and have a closer look at some critical components.

Need for caution

The primary issue stems from the use of bond proceeds when India does not have a taxonomy on green finance — a classification system that establishes a list of green economic activities. Green Finance Taxonomy is the first step in providing companies, investors, and policymakers with an appropriate definition for what constitutes “green.”

Broadly, the securities and exchange board of India (SEBI) has outlined a list of eligible sectors where proceeds from green bond issuance can be used. In 2020, the government also set up a task force to lay out a concrete road map to bolster India’s sustainable finance architecture that inter alia includes the development of a taxonomy of sustainable activities.

It sends a confusing signal as the task force is developing a taxonomy on sustainable finance, while the government declared to issue sovereign green bonds, which is only focussed on climate mitigation and adaptation. Sustainable finance is a broader concept that covers green, social, and governance aspects.

Another critical issue is a water-tight project selection criterion. There is a risk of projects being selected based on political considerations or their potential to signal to the world community a “genuine concern” for the impending climate crisis.

As a sovereign institution, the government is likely to consider non-green, for example, social aspects, in project selection rather than projects with the maximum potential to reduce carbon emissions. A dominant non-green agenda can derail the very objective of issuing sovereign green bonds.

Global best practices on green bond issuance emphasise transparency, accuracy, and integrity of information on the usage of proceeds. As issuers of green bonds, governments must disclose and report on the management of proceeds and the process followed for project evaluation and selection. In the absence of a robust green tagging mechanism, compliance can become a challenge as the proceeds of sovereign bonds are usually fungible.

To inspire market confidence in these bonds, India will have to put a green tagging mechanism in place or create a separate clearance window for the utilisation of these funds for their intended purpose.

Using proceeds wisely

Unlike corporate green bonds, sovereign green bonds will offer the government the flexibility to invest the proceeds in green projects.

This is irrespective of whether such projects are cash-flow generating or create a public good that does not yield financial returns but generates a positive externality. As a sovereign institution, the government is unlikely to default on its obligation on green bonds even if the green project is not commercially viable.

Thus, the proceeds from the issuance of sovereign green bonds can be used in climate change adaptation projects that usually find it difficult to attract private capital as most of them are considered public goods. The disasters stemming from climate change have increased manifold in India.

Some estimates suggest that the country could lose $6 trillion in economic potential by 2050 due to unmitigated climate change. On the contrary, it could gain $11 trillion in economic value over the next 50 years by mainstreaming climate and disaster resilience in infrastructure investment decisions.

The positive externalities arising from such projects will help the government enhance the climate resilience of its most vulnerable populations, thus lowering the state expenditure on future disaster relief and rehabilitation.

The bond proceeds can also be used to finance the development of carbon mitigating technologies that are still in laboratories but have high carbon mitigation or adaptation potential. These technologies often fail to attract private capital as the risk of failure is high at the discovery stage but need grants and patience capital by the governments till they attract private capital.

The proceeds of bonds can also be used to enhance the creditworthiness of the climate mitigating projects to attract large-scale private capital rather than just directly lending to these projects. Lending capital for commercially viable projects which do not require government support usually results in suboptimal utilisation of scarce public capital.

Initial reports suggest that these bonds will be rupee-denominated papers and have long tenure to suit the requirement of green infrastructure projects. It would be interesting to see how the government takes up additional debt burden in a non-disruptive manner without crowding out the private sector.

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