The financial regulators in India have taken various steps to encourage green financing. The introduction of Green Deposits and green bonds in India is a part of the endeavor. Despite the push by the regulators, the growth of these instruments remains stagnant in the country. This article briefly explores the reason for the slow growth and provides suggestions for increasing Green Deposits and issuance of green bonds in India.
Framework for Green Deposits and green bonds in India
Funds raised through Green Deposits and green bonds are used to finance activities or projects that contribute to climate risk mitigation, climate adaptation, and resilience (Green Finance Activities). Their key features are discussed below.
Green Deposits
Green Deposits are interest-bearing deposits received by the Regulated Entities for a fixed period. The Regulated Entities are required to use the proceeds of all the Green Deposits for Green Finance Activities.
Regulated Entities that offer Green Deposits are required to draft an internal policy for the issuance and allocation of the proceeds of the funds raised through Green Deposits. They are also mandated to conduct annual third-party verification and impact assessments for the allocation of funds raised by Green Deposits.
In the absence of a uniform green taxonomy in India, as an interim measure, the Regulated Entities are permitted to allocate the proceeds of Green Deposits to projects and activities relating to renewable energy, energy efficiency, clean transportation, climate change adaptation, sustainable water and waste management, pollution prevention and control, green buildings, sustainable management of living natural resources and land use, and terrestrial and aquatic biodiversity conservation.
Green bonds
The Indian Government and corporate entities are permitted to raise capital to finance Green Finance Activities by issuing different types of green bonds, which are discussed below.
Green Debt Securities: The Securities and Exchange Board of India (SEBI) permitted Indian corporates to raise funds from the domestic market for Green Finance Activities by issuing Green Debt Securities or green bonds in unlisted and listed forms. Pursuant to regulations issued by SEBI, the corporate entities issuing green debt securities are required to disclose the environmental objectives of the issuance, how the deployed proceeds will be tracked, and the process for identification of assets or the projects that will be financed with the proceeds of green bonds. Additionally, SEBI has imposed continuous disclosure requirements regarding the use of the proceeds of the issue on the entities issuing green bonds. An independent third-party has to be appointed by the issuer to review and certify the aforementioned information.
Masala Green Bonds: Indian corporate entities are also permitted to issue rupee-denominated masala green bonds to finance Green Finance Activities in the international markets. Masala green bonds must be issued in accordance with the Master Directions on External Commercial Borrowings, Trade Credit, and Structured Obligations issued by the RBI. All entities eligible to receive foreign direct investment are permitted to issue these bonds.
Sovereign Green Bonds: Further, the Indian Government is permitted to raise money to finance Green Finance Activities by issuing sovereign green bonds in accordance with the Framework for Sovereign Green Bonds issued by the Ministry of Finance. The Government is required to appoint a Green Finance Working Committee that is responsible for overseeing the issuance of sovereign green bonds, selecting eligible green projects, addressing any postponement or cancellation of an eligible green project, and providing an annual report on the allocation of the proceeds to the eligible projects.
Reasons for slow growth
It is estimated that India requires USD 2.5 trillion in investments to accomplish its goal of reducing the emission intensity of its GDP by 45 percent by 2030. However, as per estimates, India has only been able to raise 25 percent of the required funds till 2022.
Globally, debt is the most popular instrument for green financing. USD 554 billion has been raised globally for green, social, sustainability, and sustainability-linked bonds by countries in the first half of 2024. However, India’s bond market is still at its nascent stage. India has only raised approximately USD 600,000 in green bonds in the first half of 2024. This figure is quite low compared to China, which raised a total of USD 131 Billion for green bonds in just 2023.
Similarly, the funds raised through Green Deposits are lower than expected. As per the annual sustainability report of the State Bank of India, the bank had raised INR 22.39 crore till March 2024, under the Green Deposit scheme. Meanwhile, the Bank of Baroda opened over 12,000 Green Deposit accounts and raised INR 106.69 crore till June 2024.
Adequate and affordable finance for Green Finance Activities is crucial for diverting the capital from carbon-intensive sectors to more sustainable sectors to achieve India’s climate goals. However, Indian entities have not raised adequate funds through green bonds and Green Deposits. The following are the primary reasons for the slow growth of Green Deposits and green bonds in India:
High coupon rate and lack of incentives
Indian companies have to offer a higher coupon rate on green bonds compared to USD-denominated issuances due to India’s low sovereign credit rating and the risks associated with the volatility of the Indian currency. Indian bonds are generally issued at a coupon rate of 7 to 9 percent, whereas, USD-denominated green bonds have a coupon rate of 2.75 to 6 percent. Thus, it is more expensive to raise green bonds in India compared to bonds raised overseas.
Fiscal incentives play an important role in mitigating issuance costs and investment risks, especially in bond markets at a nascent stage like India. However, the Indian government has not offered any fiscal incentives, like tax rebates for green bond investors, or subsidization of the cost incurred by the issuers of green bonds and Green Deposits. Thus, compared to normal bonds or deposits, the issuers and investors do not enjoy any additional benefits in issuing or investing in green bonds and Green Deposits.
Meanwhile, the issuers have to incur additional costs associated with reporting and third-party verification for issuing green bonds and Green Deposits. This is one of the key reasons that entities prefer issuing regular bonds and deposit schemes instead of Green Deposits and green bonds.
Investors do not prefer Green Deposits or green bonds since they do not receive any fiscal incentive for investing in these higher-risk instruments.
Shorter tenure, uncertain returns
Green Finance Activities, especially renewable energy projects have a long gestation period. Whereas, the tenure of green bonds in India is generally between 3 to 10 years, with only some issuances reaching or exceeding 15 years tenure due to asset-liability mismatch and relatively higher cost of borrowing. This is a cause of concern as there may be a potential mismatch between the term of the financial instrument and the gestation period of the transitional or green projects.
Greenwashing
Companies often use terms like green, eco-friendly, or natural without providing precise data or evidence to the end consumer. There have been instances where companies emphasized favorable environmental qualities while neglecting or downplaying negative elements which might provide an inaccurate impression of a product’s overall impact.
The Indian framework has not defined ‘green finance’ or provided a specific taxonomy for the classification of projects or activities as green or sustainable. Ambiguity in the understanding of ‘green finance’ or in the classification of projects or activities as Green Finance Activities leaves room for multiple interpretations of the term and increases the likelihood of greenwashing. Thus, investors are skeptical about investing in Indian green financing instruments due to the fears the invested funds will not be utilized adequately.
Liquidity issues
Due to the reasons discussed above, not many green bonds have been issued in India. This has impacted on the volume of transactions in the secondary market as well, thereby compounding liquidity issues for green bonds.
Similarly, the present issuances of sovereign green bonds have been largely absorbed by long-term investors. Thus, an adequate supply of sovereign green bonds is not available for secondary transactions. As a result, sovereign green bonds and green bonds are not popular amongst investors due to their illiquidity.
Way forward
Alternate Financial Instruments
Instruments that can help tap long-term, low-cost debt from investor classes such as insurance, pension funds, and other long-term investors, (both domestic and foreign), to refinance bank debt for infrastructure projects are critical to meet the financing requirement for capacity addition.
Credit enhancement
Since the Indian green financing market is still at a nascent stage, the government can support the issuance of green bonds by offering partial loan guarantees, performance guarantees, insurance products, and bond wraps. Further, the Indian entities can also obtain credit enhancement through international donor agencies, like the United States Agency for International Development. This will help mitigate risks for the investors and help the issuers of green bonds develop a stronger credit history.
Governments of other countries offer credit enhancement to entities issuing green financing instruments to encourage such issuance. For instance, in 2014, the government of the United Kingdom gave loan guarantees for a bond issuance equivalent to GBP 48.5 million to finance a green biomass power project.
Green taxonomy
Indian government must also implement green taxonomy to establish a benchmark for green investments in India. This would help address the fears of greenwashing that the investors have and assure them that their funds are used to fund green projects and activities.
Incentives
To encourage entities to raise green finance, the Indian government must provide incentives, like tax benefits or subsidies and carbon credit concessional funding for green financial instruments. Tax credits or equivalent direct subsidies for holders of green bonds and Green Deposits can assist in attracting investments in these instruments and reducing financing costs for issuers.
In the United States, Clean Renewable Energy Bonds and Qualified Energy Conservation Bonds give tax credits to the holders of green bonds and provide subsidies for interest payments of the bonds to the issuers. Similarly, in China, the governments of various Chinese provinces have introduced subsidies for green bonds.
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Bharucha & Partners – Vivek Mishra and Palak Nangru
