By Srinath Sridharan & Meyyappan Nagappan

India faces a dual challenge: sustaining economic growth while meeting climate goals. To secure funds for its green transition, India must allocate a substantial budget, seek international finance, and attract private investments.

Domestic finance has thus far been pivotal for India’s low-base climate spends. According to the Climate Policy Initiative’s 2022 report, domestic sources accounted for 87% and 83% of green finance in India during FY19 and FY20. Although international sources increased from 13% in FY19 to 17% in FY20, they remain inadequate to meet India’s net-zero targets. Therefore, greater participation from international finance is crucial.

Energy transition by small and medium enterprises is key to achieving net zero by 2070. Accessing finance for them requires shifting from traditional public grants, institutional lending, and philanthropy to exploring blended finance. Social impact bonds offer a funding structure for small-budget initiatives at district, municipal, and state levels, combining impact investing, public-private partnerships, and outcome-based finance. These funding structures allow investors to provide early risk financing for green projects, encouraging more investment by offering incentives like defined outcome parameters and guarantee support for unknown risks.

Mobilisation of funds requires innovation in debt and equity instruments, coupled with the development of risk mitigation tools such as insurance and guarantees. The first step to attract capital is reducing systemic risks through a well-defined policy and regulatory clarity. Key instruments such as blended finance funds, carbon credits, and climate insurance, which can unlock additional pools of capital, must be actively promoted.

Raising climate funds is impossible without grants, concessional capital, or enabling blended finance due to the high risk and cost of climate projects. Grants and concessional capital provide crucial initial funding and lower financial barriers for projects that might otherwise be deemed too risky or expensive for private investors. Blended finance structures, which combine public and private funding, help bridge the gap between high-risk climate investments and commercial capital. Effective regulatory frameworks can simplify the complex structures of blended finance, making it easier to assess its impact and efficiency.

Restrictions on priority distribution models imposed by the Securities and Exchange Board of India to combat loan ever-greening have complicated the structuring of blended finance funds, especially those involving junior equity models. These significantly reduce the risk for commercial capital, as impact investors accept subordinate rights over returns compared to other commercial investors. Fund managers should be allowed to set up and operate funds with differentiated distribution models. For example, the Global Climate Fund (established within the UN Framework Convention on Climate Change) committed $200 million in first loss capital for the India E-Mobility Financing Program and the Green Growth Equity Fund (India’s first climate-focused fund), with the first loss capital blended at a Singapore-feeder level.

Another example where regulatory changes can offer support for blended finance is inability to pool grants and corporate social responsibility (CSR) funds into alternative investment funds (AIFs). Such pooling is not possible without Foreign Contribution Regulation Act approvals, typically not forthcoming for a private entity such as a fund. Further, there is concern that the ministry of corporate affairs will raise questions about the contribution of CSR funds toward AIFs and whether the object is to create impact or to help investors profit. Additionally, charities and CSRs will have the whole amount they contribute to such entities disallowed for tax purposes, meaning they will have to pay a high tax on it and risk their tax-exempt status being revoked. These can be solved with granular structured reporting.

The Centre’s recent announcement to introduce a Carbon Credit Trading Scheme by 2026 is a positive step, which will include both voluntary trading and compliance-based elements. However, key aspects such as the taxability, classification, and applicable tax rate for carbon credits remain unclear. For instance, the tax on sale of carbon credits could range from 30% to 10% or be exempt in certain cases depending on whether the carbon credit in question is UN-accredited and whether the company involved in the sale has generated the carbon credit as part of its business. Open questions remain on carbon credits generated using CSR funds through agro-forestry initiatives, for example. It is ambiguous if they are valid use of CSR funds and whether the sale of such carbon credits would be treated as being generated as part of its business.

Additionally, with many companies signing up to net zero pledges as part of their core business principles, can they still take a position that generating carbon credits is not a business activity? Multiple issues need to be streamlined on the regulatory side. Exchange control regulations do not permit companies to take advance amounts towards sale of goods for more than one year, beyond which it is treated as external commercial borrowing, which is highly restrictive and regulated. This creates pain points for Indian exporters of carbon credits. Permissions need to be taken from the Reserve Bank of India for each such transaction, which will slow down carbon financing.

The lack of a taxonomy for climate finance was only fleetingly addressed by the Budget. Effective detailed taxonomies are crucial for determining if investments align with national climate objectives. While a step in the right direction, it is still insufficient given the uncertainties in sector-wise benchmarks for meeting sustainability and development goals. However, given regional and sectoral differences, transition pathways will vary widely. With different regulators for different financial needs, India needs to ensure that its financial sector, corporate governance, and tax framework use a common taxonomy.

India’s insurance sector must rise to the occasion for climate risk policies to provide financial protection against the increasing frequency and severity of extreme weather events. Developing metrics and determining risks associated with climate change is urgent. Without appropriate data, launching specialised climate insurance products to mitigate financial and other risks associated with climate change, particularly extreme weather events, at affordable premiums may not be feasible. Insurance can mitigate the effects of climate change for various stakeholders, including individuals, households, governments and municipalities, and businesses.

Srinath Sridharan is a policy researcher and corporate advisor, while Meyyappan Nagappan is a partner at Trilegal Law.

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