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October, a month that is typically associated with celebration and festive fervour in India, came with some unexpected news for those who track global finance. In the first week, reports said that one of the top American national banks, JPMorgan Chase & Co, has held off on including India in its global bond index, a semi-annual review of its emerging-market debt index which is a useful indicator for investors.

This was a dampener in the usually upbeat season – India’s ability to attract foreign investment would have benefited from the inclusion in the internationally regarded global bond index. The inclusion would have further benefitted the resource-constrained green sector, which includes environmentally oriented business sectors such as the renewable energy sector.

It was anticipated that if India had been included in the global bond index, tens of billions of dollars would have poured into the Indian market. But there was uncertainty over the domestic market’s ability to handle a large amount of capital inflow.

A managing director at the Los Angeles-based firm TCW, David Loevinger, said to the media that if India is added to global bond indexes, there would be more investment for India’s journey towards a low carbon economy.

The Pavagada Solar Park in Karnataka. India’s inclusion in the global bond index could have benefitted the country’s renewable energy sector. Credit: Abhishek N Chinnaappa/Mongabay.

Talking about the significance of inclusion in a global bond index, especially from the green finance perspective, Neha Kumar, head of the India programme, Climate Bond Initiative which works to mobilise global capital for climate action says, “Inclusion in the global bond index is a broader issue, and an important one. The inclusion of government bonds would have been beneficial for emerging market investors. It could have increased their participation in Indian government securities [G-Secs] and infused the much-needed liquidity. Green finance would have automatically benefitted, especially owing to the fact that currently, the demand for green products emanates mainly from the offshore investor base and is a big opportunity to meet the massive local green financing needs.”

A funding gap of nearly $170 billion a year through 2030, in meeting India’s climate targets, cannot be bridged with domestic capital alone, she adds. But, to hinge the growth of the Indian green finance market, squarely on international index inclusion, would be a narrow lens.

Kumar lists other options for India to grow its green finance market by saying that it not only needs credible green bonds but also credible sustainability-linked bonds, loans, and transition bonds (used to fund a firm’s transition towards reduced environmental impact).

The country needs its sovereign green issuance to set the highest credibility standard and kickstart a programme of sovereign and sub-sovereign issuances, to infuse liquidity and scale, that benefits private sector investment for the green transition.

Moving on a similar track, on September 29, India announced that it was borrowing Rs 16,000 crore through the issuance of Sovereign Green Bonds. Union Minister of Finance Nirmala Sitharaman had earlier made an announcement in this regard while presenting the annual national budget in Parliament on February 1.

Coal mining in India’s Odisha district. India requires $170 billion a year through 2030, to meet its climate goals. Domestic funding alone cannot sustain the requirement. Credit: Manish Kumar/Mongabay.

In the present global climate finance structure, mobilising green finance is not an easy task for an emerging economy. Given this, the government is trying out different options to generate the necessary impetus to draw investors for green finance.

In the first week of October, just a day before the news about JP Morgan not including India in its global bond index came, the International Financial Services Centres Authority released a report in which it recommended a slew of measures to mobilise finance for the green sector.

The International Financial Services Centres Authority is a statutory authority established by the Government of India. The central government operationalised India’s first International Financial Service Centre at Gujarat International Finance Tec-City, or GIFT, in 2015.

Now, the International Financial Services Centres Authority, its expert committee has come up with the report aiming to identify existing and emerging opportunities in Sustainable Finance for GIFT-IFSC to act as a gateway to meet India’s requirements.

The committee, in its report, has recommended several short, medium, and long-term roadmaps to mobilise sustainable finance. It includes creation of a voluntary carbon market and global climate alliance.

The committee has also talked about devising a framework for promoting a regulatory sandbox for green fintech and transition bonds along with setting up a platform for sustainable lending for small and medium enterprises. “A regulatory sandbox serves as a framework that allows live, timebound testing of innovations under IFSCA’s oversight,” the report explains.

Reacting to the report, Kumar says that the International Financial Services Centres Authority, as a financial services special economic zone, and with an aim to become a sustainable finance hub, is considering putting in place many innovative regulation regimes and incentives including tax incentives (such as 0% GST and reducing withholding tax to 4% from 5%) to attract green finance from international investors.

Some of them could be replicated outside of the International Financial Services Centres Authority as well. For example, leveraging pooled investment vehicles such as Real Estate Investment Trusts, or REITs, and Infrastructure Investment Trusts, InvITs, will allow companies to monetise operational cash-generating assets.

The wide gap

All these initiatives are meant to reduce the climate funding gap that’s one of the barriers in achieving ambitious climate goals stated in the Nationally Determined Contributions, or NDCs. For this, India needs around $2.5 trillion between 2015 to 2030. It translates into $170 billion every year till 2030.

This estimate, however, is based on India’s earlier NDCs and not the latest ones that India submitted in August this year. The revised goals are more ambitious and include a net zero goal as well, which the Prime Minister of India announced during COP26. According to the report of the International Financial Services Centres Authority’s Expert Committee on Sustainable Finance, India would require cumulative investments of $10 trillion to achieve the net zero target by 2070.

India requires a cumulative investment of $10 trillion to achieve net zero target by 2070. Credit: Ravleen Kaur/Mongabay.

India managed to raise only $44 billion in the financial year 2019-’20, approximately 25% of the total target of the required budget every year for a green transition, notes a report published by Climate Policy Initiative, an independent, non-profit research group, headquartered in San Francisco in the United States. The report appeared in August and tracks green investment for the financial years 2019 and 2020.

In this amount that India raised, the contribution of international finance has been 13% in 2019 and 17% in 2020. One of the writers of the report, Neha Khanna, says that a major part of finance was raised domestically.

Most international private capital flows, according to experts, lean towards well-established industries such as renewable energy and take the least risky route. Financial transfers from the Global North to the Global South continue to be a structural impediment. This calls for novel approaches to modify risk premiums for emerging market economies.

When asked why India’s green sector is not able to lure foreign investment, Namita Vikas, founder and managing director of auctusESG LLP, an expert advisory and enabling firm working with the aim of accelerating global sustainable finance, lists a few reasons such as hedging costs which can be a pain point for foreign investors.

Hedging is a financial strategy used to safeguard investments from adverse circumstances that could result in a loss of value. For example, offshore investments, mostly foreign currency denominated, are susceptible to currency fluctuations. To protect their investment from any uncertainty, investors can choose from a variety of hedging strategies with associated expenses. It is reported in the media that the hedging cost is close to 5% in the region.

Vikas, who was also a part of the International Financial Services Centres Authority committee, says that an enabling environment, where risks are balanced, underpins the flow of investments. The renewable energy sector has gone on to become the fourth most attractive sector in India, owing to the policies and regulations that have spurred both domestic and foreign investor interest.

Regarding hedging costs, she adds, “Lowering the cost of capital would reduce the currency hedging cost and mobilise foreign capital. If the expected cost of the foreign exchange hedging facility is borne by the government, the cost of debt, renewable energy, and the cost of government support may be reduced. The Indian government has shown interest in providing a government-sponsored exchange rate hedging facility. However, the design of the facility would need to be carefully considered, given that currency movements can be uncertain and volatile. There is also a need to look for innovative financial structuring to enable foreign capital flow such as green securitisation, India’s Viability Gap Funding [VGF] model, supplier-based finance, and sovereign green bonds to attract foreign capital into the Indian markets.”

Sectoral preferences

The Climate Policy Initiative report gives sectoral trends as well noting that the total fund flow towards climate mitigation was almost equally split between clean energy (42%) and energy efficiency (38%) while clean transport received just 17%.

Within clean energy, solar projects received the greatest share of financial investments accounting for 41% of the total finance flows to the clean energy sector. Interestingly, when clean transportation received the maximum funding (96%) from public sources, investment in the energy efficiency sector was primarily from the private sector (91%).

The report also gave details of funding for adaptation saying that the total amount of green finance was $5 billion per annum. It was mostly funded by central and state government budgets.

Underlining the bigger trend of green finance in India, Khanna says, “Debt accounts for about 50% of total finance flows, equity for 26%, and government and budgetary expenditures at about 19%. Flows to all sectors increased from the previous years. However, these flows were limited to certain sub-sectors such as solar in the clean energy segment and Mass Rapid Transport System [MRTS] in the clean transport segment.”

According to the Climate Policy Initiative report, the clean transport sector received only 17% of the total funds ($44 billion) for climate mitigation. Credit: via PxHere.

Talking about the low contribution of the private sector, Namita Vikas says that it could be because the nature of risks in the green sector is largely unknown or unaccounted for.

Unlike the traditional business models which are tried and tested, businesses in the green sectors are yet to have a well-established risk management structure. As a result, only large issuers have been prominent in the green finance space – owing to their capital prowess and risk-bearing capacity – whereas the mid to small companies have remained off the radar.

Further, the private sector’s nascent understanding of green sector finance is another challenge, which also leads the private sector to perceive bankability issues such as high transaction costs, long gestation periods, and higher risk-return profiles – referred to as risk perception.

“While the government is keen on steering away from carbon-intensive assets, given the scale of investments required, public sector investors will need to act as facilitators rather than the sole investor,” Vikas adds.

Private capital needs to be roped in through de-risking mechanisms, such as guarantees and catalytic capital, as deployed in blended finance structures. Policies and regulations need to be made conducive for the private sector to participate, along with appropriate pricing and guidance on innovative financial products for green finance. In essence, the public sector needs to institutionalise mechanisms for the private sector to participate in order to achieve a more balanced ratio for green financing.

Challenges to track green finance

In India, it is not easy to track green finance as there is no organised effort to develop a system in this regard. The Climate Policy Initiative report also underlines this fact by saying, “While this report presents the most comprehensive information available, methodological issues and data limitations persist. Tracking green finance faces multiple issues related to the availability, quality, and robustness of investment data on both public and private sectors.”

When asked about the challenges faced during the study, Khanna says that there is non-availability and trackability of disbursements. Extracting this information can be challenging due to the lack of an effective Measurement, Reporting, and Verification system in India.

The Public Financial Management System in its current form does not provide granular information about the flow of finance and its end use. To overcome this challenge, the team has had to resort to the use of legally available mechanisms such as the Right to Information Act, 2005, which was cumbersome and only partially effective, she adds.

About other challenges regarding tracking green finance, Khanna underlines the difficulty in green tagging of the budget entries. “The lack of a harmonised green finance taxonomy in the country, and non-standardised reporting of data, make green tagging of domestic entries arbitrary and vulnerable to the user’s discretion,” she says.

Namita Vikas emphasised the need for a uniform definition and a taxonomy for green finance that is currently not in place in India, which makes it harder to track the green sector in India for investment purposes. Currently, disclosures serve as the primary source of ESG/green information. While think tanks and some organisations have attempted to track green financial flows, it is largely on the back of contextualised and customised definitions.

This article was first published on Mongabay.