Indian sovereign green bonds are critical for establishing a comprehensive sustainable investment architecture, thus a concrete roadmap needs to be charted
With the sovereign green bond debut, the Government of India has opened a new avenue to finance its climate targets and green ambitions and has finally entered the green sovereign club. The Ministry of Finance had announced to raise US$ 2 billion—nearly 1 percent of the overall borrowing—in the fiscal year 2022-23 through a sovereign green bond denominated in INR. Sovereign green bonds, even though late entrants in the global thematic bond market, are rapidly emerging as a key part of the sustainable finance arsenal aimed to help governments shift finance at scale in line with their Paris and SDG targets.
The performance of the first tranche has been better than expected with the issue selling at a 5-6 basis points lower yield than the sovereign yield of similar tenure. Most analysts had predicted a 2-3 basis point advantage over vanilla (non-green) offerings by the sovereign. The issuance was more than four times oversubscribed and out of the total of 96 bids, the five-year bond was sold to 32 investors and the 10-year to 57 investors, according to the Reserve Bank of India (RBI) The five-year bond was priced at 7.10 percent and 10-year bond at 7.29 percent. The six-basis points ‘greenium’—higher price investors pay for debt raised for green projects is thin but encouraging given that the issuance is in local currency, onshore and local green market, is at best fledgeling.
To attract dedicated international ESG investors, the RBI opened the auction to non-resident investors through the Fully Accessible Route which exempts foreign participation from investment caps for ‘specified securities’.
Just before the issuance, based on the engagement with international and domestic investors, the regulators took a few key steps to attract a good market response. To attract dedicated international ESG investors, the RBI opened the auction to non-resident investors through the Fully Accessible Route which exempts foreign participation from investment caps for ‘specified securities’. For local institutional investors, the insurance regulator, Insurance Regulator and Development Authority of India (IRDAI) allowed the bonds to count toward insurers’ required infrastructure investments. And for banks, the RBI clarified that the investments in green bonds would qualify towards Statutory Liquidity Ratio (SLR). This is the minimum percentage of deposits that banks need to invest in liquid assets such as government securities. The larger chunk of the issue has naturally been picked up by the PSU banks and insurers, while international investors have participated cautiously, despite the sop.
This is an important indicator to accelerate some of the initiatives and possible incentives that can be brought forth by India’s financial policy and regulatory apparatus to harness maximum benefits from the existing international investor appetite and unlock the local demand for sustainable investments. The size of the challenge and opportunity is large. Green finance flows in India from domestic and international sources are only a fourth of what is projected as an annual requirement (US$ 170 billion) through 2030. In relation to the size of India’s economy and the massive financing needs to fund its green transition, thematic debt raised through capital markets offers a great opportunity.
The sustainable bond market which comprises green, social, and sustainable (GSS) bonds has grown rapidly. It reached nearly US$ 3 trillion in June 2022 with the green theme dominating the market at US$ 2 trillion globally. Indian non-sovereign issuers have issued US$ 25 billion till June 2022 as GSS bonds predominantly in the hard currency according to the unpublished database Climate Bonds Initiative. This reflects a huge room to grow given a decent pick-up eversince the first green bond was issued in 2015. That said, in the APAC region, India trails six places behind China, Japan, South Korea, Australia, and Singapore.
Green finance flows in India from domestic and international sources are only a fourth of what is projected as an annual requirement (US$ 170 billion) through 2030.
Sovereign green bonds can play a huge role in realising this opportunity. Performance of individual sovereign issuance apart, the market-making role they play results in far greater strategic benefits through demonstration effect, liquidity infusion, setting best practice yardstick for private issuers on the integrity of the use of proceeds, benchmark pricing and stimulating investor appetite. A BIS paper suggests that the “inaugural issue of sovereign green bonds tends to tighten standards for overall green issuance in that country. After such an issue, not only does the annual number of corporate issues tend to increase across jurisdictions, but so does the percentage of corporate issuance with second-party opinions. This is apparent in both advanced and emerging market economies”. As an example, after the United Kingdom issued its green gilt in 2021, non-sovereign issuance grew by 79 percent the same year. Separately, in a 2021 sovereign issuers’ survey carried out by the Climate Bonds Initiative, the majority of the sovereign issuers indicated diversification of the investor pool and the creation of a local green bond market as their primary motivation. They often provide investors with safe, liquid investment opportunities freeing up capital for other lower-rated and less liquid debt securities. Increasing the size of the local green market could also make the greenium more sizable.
Indian sovereign green bond is in local currency. The appetite for rupee-denominated green bonds by global fund managers will be an important construction site, both for international investors as well as Indian policymakers. Given that Indian bonds offer higher yields than debt instruments in advanced economies and several emerging market economies, rupee-denominated offshore green bonds could be a potential segment to grow in the future to attract greater foreign investment. In the domestic market, local currency issuance will allow for a larger segment of smaller green transactions to access the capital market. International investors typically chase large deal size generally above US$ 200 million which risks a significant pipeline of smaller investible green projects getting crowded out.
The absence of a dedicated pool of green capital, however, inhibits domestic demand. Sovereign green issuance offers an opportunity for regulatory support here. The pension and insurance regulators—Pension Fund Regulatory and Development Authority (PFRDA) and Insurance Regulatory and Development Authority (IRDAI)—could create mandatory carve-outs for institutional investors to invest some percentage of their portfolio in green projects. This would create the much-needed domestic demand and incentive for the local green bond market to grow.
International investors typically chase large deal size generally above US$ 200 million which risks a significant pipeline of smaller investible green projects getting crowded out.
The ultimate test, of course, for any green issuance comes from the integrity and transparency of the use of proceeds. This draws us to the project categories laid out in the sovereign green bond framework which has received a medium green rating by Cicero, the Second Party Opinion (SPO). The Green Bond framework encourages investment to advance energy efficiency, reduce carbon emissions and greenhouse gases, promote climate resilience and/or adaptation and improve natural ecosystems and biodiversity, especially in accordance with SDG principles. The framework clarifies that the sovereign green bond proceeds can be used to finance and/or refinance expenditure in part or whole for eligible green projects falling under eligible categories.
The SPO, however, also highlights a lot of project categories where criteria are loosely defined. This can create ambiguity regarding what some of the expenditures might finance and if they would lock in broader climate risks associated with government spending. Such projects will be a potential red flag for international green investors. That said, for the current issuance, there is ample scope to prioritise those assets and projects that can be backed by clear metrics in line with India’s Paris commitment.
A few examples taken from the green bond framework illustrate this point. Clear categories include investments in solar/wind/biomass/hydropower energy projects that integrate energy generation and storage; public transportation including its electrification and transport safety but subsidies to adopt ‘clean fuels’ like electric vehicles including building charging infrastructure would need better metrics for clean fuels and clarification whether they include facilities producing biomass/biofuel, and/or heating/cooling/co-generation facilities using biofuel/biomass.
Thus, adhering to best practices/criteria for the selection and evaluation of nominated assets and expenditures can hugely streamline the effort of the Green Finance Working Committee as it aims to establish a green sovereign programme outlined in the Green Bond Framework. It can help build and retain the confidence of investors, avoid greenwashing, and offer a clear sense of the potential impact of the investment while setting a benchmark for public and private sector issuers.
Adhering to best practices/criteria for the selection and evaluation of nominated assets and expenditures can hugely streamline the effort of the Green Finance Working Committee as it aims to establish a green sovereign programme outlined in the Green Bond Framework.
The budget is expected to mention the list of projects and expenditures that will be covered under the current issuance. Hopefully, those backed by clear criteria will be prioritised for inclusion. The ambiguity over classification can be substantially reduced through a sustainable finance taxonomy to help define what can be credibly funded, build a common language for such investments and reduce information asymmetry in the market.
Indian sovereign green bond needs to be seen as one of the critical building blocks of a comprehensive sustainable investment architecture and strategy. Concomitantly, concrete steps will need to be taken to chart a cogent roadmap. This will include the identification and creation of a credible investable pipeline of green projects and expenditures, taxonomy (which is already in the works) that helps classify such investments and expenditures for a visible pipeline for future issuances, intensified domestic and international investor engagement, independent verification and reporting essential for market integrity, and regulatory support and incentives to establish local and international investor demand for local currency green debt. India can move ahead on some of these steps during its G20 presidency and foster efforts for building a systematic programme of local currency sovereign green issuances by emerging economies.
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Ms Neha Kumar heads the South Asia Programme for the global not-for-profit Climate Bonds Initiative (CBI) and is based in Delhi. She drives policy practice ...
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