India is the third-largest emitter of carbon dioxide (CO2) globally, following China and the United States. As a nation committed to combating climate change, India has set ambitious goals. The country aims to reduce its emission intensity by 45% below 2005 levels by 2030 and to achieve net-zero emissions by 2070. However, achieving these goals requires significant financial resources, far beyond the current budget allocations.
In July 2024, the Indian government expanded its energy budget to $8.2 billion, up from $6.6 billion the previous year. While this increase is substantial, it is still only a small portion of what is needed. Experts estimate that India requires $250 billion annually in clean energy investments to meet its climate goals. The vast gap between the available funds and the required investment has led to the promotion of green bonds as a solution.
The Role of Green Bonds in India’s Climate Strategy
Green bonds are financial instruments that allow companies and governments to raise debt at a lower interest rate specifically for green energy projects. Despite the urgent need for such investments, India’s green bond market remains underdeveloped. As of March 2023, the market was valued at just $30 billion, a small fraction of the $2.7 trillion global green bond market. This represents only 3.8% of India’s $500 billion+ domestic corporate bond market.
Recognizing the potential of green bonds, the Indian government is making efforts to expand this market. In 2015, India entered the green bond market, with banks and energy companies being the primary issuers. The government issued its first sovereign green bond in January 2023, raising ₹36,000 crore. This move was intended to attract foreign portfolio investors (FPI) who were excited about India’s green bond offerings.
To capitalize on this interest, the government set a target to borrow ₹12,000 crore through green bonds in the first half of FY25, with plans to increase this to ₹20,000 crore–₹25,000 crore for the entire fiscal year. However, the response so far has been disappointing. The government has raised only ₹1,697 crore, just 14% of the planned issuance, as it struggled to find favorable bids.
Understanding the Challenges Facing Green Bonds
One of the key issues in the green bond market is the concept of a premium. When an investor is willing to accept a lower coupon rate for green bonds compared to traditional bonds, this is known as paying a premium. Investors might do this because green bonds offer benefits like portfolio diversification, a lower risk profile, and alignment with long-term green projects. However, when no premium is paid, the purpose of green bonds—providing low-cost financing for green projects—is undermined.
The tepid response to India’s green bonds can be attributed to several factors. Despite foreign portfolio investors buying Indian government bonds worth ₹77,379 crore between September and February, their interest in green bonds has been lukewarm. One major concern is the liquidity of these bonds. Since August 16, no green bonds have been exchanged, highlighting the issue of low liquidity. This lack of trading is partly due to the small size of long-term bonds, which are typically bought by foreign investors.
To address these concerns, the Reserve Bank of India (RBI) is planning to introduce trading of sovereign green bonds on the International Financial Services Centre (IFSC) platform in Gujarat. This platform could help foreign investors participate in the Indian green bond market while offering them tax benefits. By improving liquidity, the government hopes to make green bonds more attractive to investors.
Another challenge is the unpredictability of bond issuance. Only one of India’s green bonds met the issuance threshold for inclusion in JPMorgan’s bond index. This inclusion is crucial because it attracts investments from mutual funds that track the index. However, the government’s decision to remove 14- and 30-year bond issues from index-eligible securities has added to the uncertainty.
India’s Efforts to Strengthen the Green Bond Market
Despite these challenges, India is working to build a robust green bond market. In 2024, India’s environmental, social, and governance (ESG) issuance reached $15.6 billion. However, this volume is still lower than that of other Asian nations like China and Japan. One reason for this is the lack of variety in financial products available in the green bond market. The government currently concentrates India’s sovereign green bonds on renewable energy projects. It also focuses on the electrification of transportation systems.
To address this, the Indian government, along with the RBI and the Securities and Exchange Board of India (SEBI), is working to introduce more green financial products. In the July Budget, the Finance Minister announced plans to develop a taxonomy for climate finance. The government expects this taxonomy to enhance the availability of capital for climate projects. It will provide clear guidelines on what constitutes green financing.
India’s green bond market is still in its early stages, but the government is taking steps to strengthen it. By addressing the challenges of liquidity, unpredictability, and lack of variety, India aims to attract more investment in its green bond market. These efforts are crucial as the country strives to close the investment gap needed to achieve its ambitious climate goals.
