It would be prudent to start with expenditure items that have a clear and strong link to central and state climate-action plans
By Sandeep Bhattacharya & Shubham Gupta
Green bonds have been gaining traction among governments worldwide for mobilising resources for green projects or refinancing them. Since the first sovereign issuance by Poland in 2016, 22 countries have issued sovereign green bonds, raising more than $80 billion. Despite the pandemic, the market for sovereign green bonds remained resilient in 2020 with both new issuances and re-openings. The year ended on a high with the UK announcing its plan for its first-ever sovereign green bond issuance in 2021 and the Kingdom of Thailand tapping its earlier issuance to raise an additional 20 billion Thai baht (about $665.8 million) to finance a rapid mass-transit line in Bangkok.
In simple terms, green bonds are debt instruments that can be used by governments and their entities, international organisations as well as the private sector to raise money for projects that demonstratively contribute to climate mitigation or adaptation. With more than $1 trillion of cumulative issuances to date, green bonds have come a long way since their inception in 2007 and the first sovereign issuance in 2016.
Investors are motivated over investing in green assets, and, in many cases, have been driving a movement towards a climate-friendly future. Interestingly, half of the government green bonds globally have enjoyed “pricing premiums” compared to their vanilla equivalents (non-green, business-as-usual government securities), indicating a strong demand for it. Besides pricing, issuers have highlighted several other benefits, including establishing political leadership and commitment towards climate action, better alignment between their climate policies and financing, and diversification among institutional investors (such as pension funds, sovereign wealth funds, etc.) keen on environment, social, and governance (ESG) considerations. They also contribute in gearing domestic financial markets for green transition.
Government green bond issues are backed by those public assets that are either contributing to low-carbon development or building capacity to cope with and be resilient to climate change. Such assets include investment in watersheds, early warning systems for disaster risk management, large renewable energy (RE) projects, clean transportation, etc. It also includes some subsidies or tax-breaks that enable the creation of green assets by households and businesses such as solar rooftop panels, solar pumps, and energy-efficiency equipment.
The first issue may take time and effort to put necessary infrastructure and institutional arrangements in place. However, the learning curve is steep. With few subsequent issues, the mechanism gets automated like any other bond issue.
In India, the Securities Exchange Board of India (SEBI) introduced disclosure requirements for the issuance and listing of green bonds in 2017. Since then, India has become the second-largest issuer of green bonds (after China) among emerging markets with cumulative issues worth more than $10 billion by private companies and public sector entities such as the State Bank of India (SBI). However, there has been no green bond issuance yet by either the Central or state governments.
Issue of green bonds must be considered by the Union government as well the states. Managed by Reserve Bank of India (RBI), market borrowings have become an important source of deficit-funding for them. In particular, state governments’ reliance on market borrowing (as a proportion of their total annual borrowing) has grown steadily in the last few years, from nearly 60% in FY16 to approximately 90% in FY21. However, their investor base remains narrow. Most securities issued by states (termed as State Development Loans or SDLs) are owned by public-sector banks, insurance companies and provident funds. While these securities have ‘near sovereign, risk-free’ status, Foreign Portfolio Investors (FPIs) have shunned investing in them. Since the opening of the SDL market for FPIs in 2015, their participation remains under 5% of their allocated limits. Limited FPI investments have gone mostly to SDLs issued by Gujarat, Tamil Nadu, Maharashtra, and Karnataka. This, despite RBI’s emphasis on their safety and suitability for investments by FPIs. Absence of FPIs affects trading and liquidity that is desirable for a vibrant secondary market for SDLs.
Issuance of green SDLs can contribute to addressing this issue while attracting investments into projects which are needed to build climate-resilience at the local level. Mobilising funds for climate action is a major challenge for the states. Covid-19 has made their fiscal position extremely strained, increasing their reliance on market borrowing for discretionary spending on climate-related interventions. While the benefits of large-scale green transition to RE, electric mobility, etc., are much talked about, less mentioned are the facts that climate change is putting our industrial, agricultural and health systems under severe strain and reducing productivity of our farms and factories, and increasing the disease burden. This poses grave threats to the nation’s sustainable development agenda. Green SDLs can help state governments attract diverse investors who are willing to support them in their efforts to reduce such vulnerabilities, and possibly offer better pricing.
It would be a significant undertaking, with the potential of unlocking multiple cascading benefits. Green bond issues will also help raise their profile among climate-responsive investors. Public assets and expenditure made by state governments play a pivotal role in supporting national climate commitments and building resilience of communities directly impacted by climate change. To begin with, these assets and expenditure can be relatively easily identified and re-financed through green SDLs. It would be prudent to start with expenditure items that have a clear and strong linkage to state and national climate-action plans to build investor-confidence.
India’s strong political commitment and leadership position on climate issues, progress made so far in the achievement of Nationally Determined Contributions (NDCs) under the Paris Agreement, and stable macro-economic environment makes it an attractive proposition for responsible investors looking to diversify their holdings. It would be interesting to see if states are willing to pursue this opportunity. In the past, subnational leaders have undertaken commendable initiatives which have earned national and global recognition. There is no reason why they can’t go first in issuing green bonds.
The author is India project manager, Climate Bonds Initiative, and manager (climate finance), Climate Resilience Practice programme, World Resources Institute India