The Emanation of Green Bonds in India: An instrument of Sustainable Financing

[By Dhairya Jain]

The author is a student of Hidayatullah National Law University.

Introduction

In light of India’s projected 3,000 GW Renewable Energy (RE) potential, the nation plans to increase its RE capacity augmentation goal to 175 GW by 2022. Higher capital investments, projected at roughly USD 200 billion over the next years, would be necessary to achieve the much higher capacity objective, which will increase energy security and access while also creating more jobs. The present project finance sources in the Indian market are exhaustive enough to satisfy the expected capital and investment needs. In order to attract a larger pool of potential investors, such as pension funds, sovereign wealth funds, insurance firms, and the like, new financial instruments and financing methods must be developed. Another pushing reason for the need to introduce new funding sources and mechanisms in India is the high cost and short duration of project finance presently available for RE projects.

The need for alternative instruments of finance

India must diversify its capital sources in order to accomplish its capacity addition objectives despite the fact that the sector’s demand for capital has been low in the previous two to three years owing to policy changes and the economic recession. In India, the following are the main challenges that are preventing the funding of RE projects:

  1. The Environment of high interest rate: It is believed that the unattractive terms of debt and exponentially high interest rates discourage the growth of RE projects. It leads to increasing the upfront cost by a margin of 24-32%, as compared to projects financed in The United States and The Europe.
  2. Non-Availability of debts of longer tenure: Due to the short-term nature of the capital that these banks generate, Scheduled Commercial Banks in India are typically comfortable with loan tenures of five to seven years. Nearly 79 percent of bank deposits in 2009-10 had an average maturity of less than three years, according to RBI figures. However, there are a few examples of infrastructure projects, including RE projects, that have been able to get ten-year terms.
  3. Due to the banks’ short-term lending, loans in India tend to have variable interest rates rather than fixed ones. An expanding economy means that long-term hedging products are often unavailable. Variable Interestsmake cash flows to equity investors less reliable when borrowing at a variable interest rate.
  4. As a result, banks are limited in their ability to invest in a single area or technology. The RE sector falls within the overall power sector restriction, which generally lacks the depth necessary for large-scale finance of RE projects. More banks will approach and breach their sector exposure restrictions for the power industry, leaving RE projects without enough bank funding as a result of a growth in RE.

As a result, the financial market will need to provide tools and procedures that fit the special needs of the sector, such as lengthy duration, significant pumping of funds, and active engagement by a range of investors, in order to meet the massive deployment of RE in the nation.

What are green bonds?

In the world of finance, a green bond is a fixed-income vehicle created expressly to fund environmental and climate change initiatives. Most of the time, these bonds are linked to the issuer’s assets and backed by its balance sheet. This means that they usually have the same creditworthiness as the issuer’s numerous different debt liabilities. The same rules apply to green bonds as they do to any other kind of business or government debt. lenders issue these securities in order to obtain funding for initiatives that have a good effect on the environment, such as ecological reconstruction or emission reduction..  When these bonds reach maturity, investors will be able to cash in on their investment and profit. Investing in green bonds might also result in tax advantages for investors. ​

Investors are increasingly considering green infrastructure investments as part of their social and corporate responsibility efforts in light of the growing emphasis on ecologically friendly practises. As a result, Green Bonds may be used to free up previously locked-up private funds for use in environmentally friendly initiatives.

It’s still unclear what counts as “green,” although sectors such as RE, reusing and reusing garbage, water conservation, and afforestation all fall under the umbrella of “green.” If the profits of the bond offering are utilised for green initiatives, investors may make an informed decision about the project’s viability. These instruments are also being defined and governed by standards such as the Green Bond Principles.

Benefits of Green Bond to various stake holders

The advantages of green bonds have to be viewed from the perspective of its four stake holders which include: Investors, Issuers, Lenders and the state.

Benefits to the Investors

To guard against the dangers of climate change, some institutional investors promote environment-friendly corporate practises, while others diversify their investment portfolios..Green assets’ long-term competitiveness, the bond market’s better liquidity, and the minimal operational risk they carry make them an appealing investment option for institutional investors.

Benefits to the Issuers or project developers

For the time being, project developers in India have few alternatives when it comes to contacting financial institutions (FIs)Is that provide short-term loans with high interest rates. Developers will be able to get foreign funding at competitive conditions thanks to Green Bonds.

Increasing capacity without corresponding equity injection is possible via the use of longer-term bonds with bullet payment schedules. Increased annual growth rates of 30-50 percent for the same equity base may be achieved by redeploying surplus cash flow.

Benefits to the lenders or financial institutions

There are self-imposed constraints on FIs in India’s financial industry. By issuing RE portfolios of Green Bonds, FIs may unload holding assets while still using the revenues to fund new projects and stay within the sector restrictions.

With short-term deposits, the asset-liability mismatch is a major problem for Indian banks. The absence of long-term liquidity in the system prevents banks from obtaining long-term loans for the industry. Green Bonds are a solution to this problem since they enable FIs to raise long-term capital. It is also possible to securitize project portfolios at a given maturity level to alleviate asset-liability mismatches for FIs.

FIs may demand risk premiums through price arbitrage that may arise during the issuing of Green Bonds owing to the low-risk portfolio and possibly better ratings in open markets, because of the rollout of “mature” projects via Green Bonds.

Benefits to the State

Government of India will need massive investments in the RE industry with an ambitious objective for 165 GW of installed RE by 2022. This is a big target. Alternative funding sources should be  explored  in this regard. When it comes to financing renewable energy projects, Green Bonds can help India attract the finance needed to reach its National Action Plan on Climate Change objective. Expansion of foreign reserves and reduction of India’s reliance on imported energy are both possible as a result of increased inflows of international money.

Conclusion

Investment and participation from several stakeholders are necessary to create green infrastructure. Globally, the public and commercial sectors of every country, as well as organisations like the World Bank, should provide the green bond market with enough capacity building and experience in green projects.

To link with the established capital markets and investors, a healthy green bond market would also need to adhere to similar norms and rules. This will aid in directing money toward sustainable development. In the goal of sustainable economic growth, it makes logical for governments to choose green bonds over oil bonds.

References

  1. World Economic Forum. 2022. How shifting to green bonds can help shape India’s transition. https://bit.ly/3RgHwJx
  2. The Economic Times. 2022. Decoding green bonds https://bit.ly/3ATLXVh
  3. com. 2022. Green Bonds: Definition, Type and Benefits https://bit.ly/3Kt7N5b
  4. Bagaria, R., Green Bonds in India Green Clean Guide. https://bit.ly/3ctXykw
  5. 2022. What Is a Green Bond? https://bit.ly/2G5g8ZZ 
  6. Niti.gov.in https://bit.ly/3XnGWxl

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *

Contact Us

Kerwa Dam Road., 
National Law Institute University, Bhopal
Madhya Pradesh, India. 462044​.

write to us at – cbcl@nliu.ac.in