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Greening the Union Budget: Reality or Distant Dream?

Will the 2021 Union Budget focus its attention on greening the post-COVID Indian economy?

Amidst the COVID-19 pandemic, India is on the anvil of its 2021 budget, that is slated to be “like no other in the past”, as per Finance Minister, Nirmala Sitharaman. The focus of the FM seems to be on strengthening engines of growth, including reviving demand and boosting trade. While doing this, India needs to also consider the huge opportunity offered by mainstreaming green finance.

It is certainly time for India’s financial architecture to turn to sustainable finance, with a particular focus on green, as a starter. The country’s renewable energy (RE) capacity has grown multifold at a 5-year CAGR of ~12% from 2014 to 2019, higher than the ~8% CAGR seen globally. The traction has been significant in solar, where India’s 5-year CAGR is ~57%, more than double of the ~27% seen globally. These numbers are resultant of the government’s focus on achieving its ambitious targets and facilitating robust policy implementation.

The country’s commitments to addressing climate change as per its NDCs include a 33%–35% reduction in emissions intensity of the GDP by 2030 (amounting to below the 2005 levels), an increase in the share of non-fossil-fuel sources to 40% of energy capacity by 2030 and creating an additional carbon sink of 2.5–3 Gt CO2-equivalent through forestry and afforestation by 2030. With economic recovery in a post-pandemic India underway, government spending would need to be reprioritised.

While subsidies as a percentage of total expenditure reduced from its recent peak of 18% in 2012-13 to 11% in 2019-20, capital expenditure (which includes infrastructure) remained largely consistent between ~11-14% during the same period. Infrastructure spending must be pushed, especially for green sectors like water, green buildings, e-mobility, the circular economy, climate smart urban infra, non-chemical agriculture etc. given that these climate-linked sectors alone posed a huge investment opportunity of USD 3.1Tn, between 2018 and 2030 for India.

There have been debates over creating specialized institutions to mainstream sustainable finance vis-à-vis reorienting the existing financial institutions (FIs) to play a more focussed role. The formation of such specific institutions in India has boosted green sectors. For instance, loan sanctions at IREDA, a public sector financier of renewable energy projects, grew at a ~13% CAGR to ~INR 127 billion between 2015-16 and 2019-20. During the same period, overall bank credit in India to the commercial sector grew at a ~9% CAGR. Similarly, NABARD, the public sector financier for agriculture and rural development, saw long-term refinance credit grow at a ~13% CAGR to ~INR 78 billion during this period, while the Pradhan Mantri Mudra Yojana, a government loan scheme to small businesses, saw loan sanctions grow at a sheer ~25% CAGR to ~INR 3.3 trillion in this period. Such initiatives, then, are not only boosting financing for critical sectors, but also providing a level of comprehensiveness and standardisation for green markets so as to function more effectively and successfully.

The Finance Ministry may want to consider the following initiatives to further strengthen existing sustainable finance initiatives;

  1. Bank of Sustainable Finance

A bank with Sustainable Finance as its sole focus would better prepare India for a green future. 

A dedicated Sustainable Finance Bank would not only bring in focus and the necessary capital for green sectors, but enable innovation of retail products and project finance, by tapping into private capital. Well-capitalised through public finance or existing national funds like Clean Energy Fund, CAMPA and Clean Ganga Fund, would provide the initial kickstart to such an institution.

Proactively, sourcing risk capital from Green Climate Fund, that was set up by at COP-15, for supporting developing countries in climate mitigation and adaptation, would help in insulating financial risks within sectors like water and e-mobility.

Transitioning from brownfield to green projects as a part of decarbonisation, needs finance. Transition Finance is a new emerging funding instrument, a focal point of ESG and financial markets designed to help “brown” companies shift to greener business, thus bridging the gap between traditional and sustainable financing, as businesses begin the journey to net zero.

For India, coal would remain a major part of its energy mix and therefore specific focus on Transition Finance, is critical. Alternative financial instruments like green bonds that provide investor diversification, and a potential pricing advantage, have been catering to the demand for infrastructure investments so far. For a Sustainable Finance Bank, besides acceleration on green bonds, issuing transition bonds would be a sizeable opportunity, thus contributing to a climate-neutral, circular and resource-efficient economy in India.

The budget may look at providing a direction to introduce preferential policies and measures to support the acceleration of green or transition bond markets by giving exemptions for income tax from investments in these bonds, or/and make interest on green bonds tax-free for institutional investors. Considering the possibility of transforming existing institutions like IREDA into a specialised green bank or mandating FIs to take targets on green investments would also surely help incrementally towards the road to economic recovery.

The addition of Renewable Energy carve out or the recent revision to priority sector lending to widen credit availability to financially excluded areas demonstrates the regulator’s intent and priorities. Similarly, in order to boost the green sector, a specific approach within PSL would not only encourage boards of banks to allocate capital to assets accordingly, but also evolve with a holistic strategy geared towards a green economy.

  1. Guidance on ESG Risk Assessment

Standardisation of ESG Risk Assessment would help mitigate risks and create a level-playing field for foreign investors.

The Basel Framework includes guidance on capital adequacy, market liquidity risk and stress testing to ensure a functional financial system which is resilient to uncertainties. While these broad categories of risks collectively cover the range of uncertainties, there is no structured approach to mitigate environmental and social risks. While, most BASEL members, (India included) agree that climate change poses a credible threat to financial stability, a mandate towards strong governance and risk management, through Board-level committees that oversee social and environmental impacts, would help mitigate a range of future climate possibilities that could shock Indian financial institutions’ balance sheets.

What India needs is comprehensive policy guidelines which include a definition or taxonomy on green or sustainable finance, bringing clarity on what qualifies, enable asset tagging, resulting in taking targets to bring in a larger mix of green finance in porfolios

Inclusion of ESG risk assessment under RBI’s risk-based supervision, will enable banks to assess ESG and climate-related financial risks, thus maintaining asset quality, future-proofing, planning for the long-term for future credit portfolio, loan pricing etc., all of which guarantees to mitigate risks and evolve with a risk-adjusted return. This would also help towards market standardisation and a level playing field for market participants from investors that would be bound by EU taxonomy or TCFD.

  1. Green Credit Rating System

Credit Ratings for green instruments would facilitate raising capital for green investments and bring standardisation and credibility to sustainable finance instruments and ESG performance.

There is a growing trend by rating agencies to adopt green standards. But the absence of a standardised system in India, is unfavourable to implement credit risk evaluation for green project financing at a large scale. Establishing an Indian green credit rating system would, not only, help bring in an element of market standardisation, but also, enable businesses to raise funds at competitive rates basis ESG performance, fuelling uptake of green investments and restraining new brown investments.

For India, the challenges for an economic recovery are intertwined with the current issues afflicting the global trading system such as bank asset quality challenges, climate risks and other systemic risks. For this budget to be “like no other in the past”, it would not only need to be holistic in its approach towards COVID-19 economic response and recovery, but balance economic and financial stability, while stimulating growth geared towards a low-carbon economy.

auctusESG is a global advisory firm on Sustainable Finance and ESG

3 Comments

3 Comments

  1. Ashok Kapur, IAS (r)

    February 15, 2021 at 5:42 pm

    Namita, very comprehensive article, giving an overview of the entire scenario. Green Credit Rating is a very innovative idea.

  2. Krishnakumar Raman

    January 31, 2021 at 6:11 am

    Timely article highlighting the critical challenge Namita!
    Globe is currently changing gears and is ‘en route’ to walking the talk in expanding the footprints of Global Finances to ESG and Sustainable Development Goals.
    Soon ESG and Sustainability are not just one more ‘box’……but ‘the box’ that needs to be ticked.
    India HAS a big role to play in the Sustainable/Renewable growth about to explode. A Bank with Sustainable Finance as its Focus is a much needed platform for India to integrate with the global shifts.
    Your recommendations are in the right direction.
    Well done.

  3. Prashant Vaze

    January 28, 2021 at 4:49 pm

    Congratulations Namita on this well thought out and succinct blueprint for actions the government and RBI could take. In the UK the Green Investment Bank provided a centre of excellence where finance professionals expert in assessing new technologies like off-shore wind helped the industry take-off. A Bank of Sustainable Finance (perhaps adapting the mandate of an existing institution like IREDA) could provide an excellent boost for technologies like green-hydrogen to decarbonise India’s steel and fertiliser sectors.

    The RBI is already undertaking thoughtful work on climate risk, particularly examining impacts on food inflation, but the elephant in the room is FI exposure to coal-finance which will soon become stranded if solar and wind (plus storage) takes away their markets.

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