Understanding Sovereign Green Bonds and Weak Investor Demand in India

Sovereign Green Bonds (SGrBs) have emerged as a crucial financial instrument for governments worldwide to fund climate-resilient and environmentally sustainable projects. India, like many other emerging markets, has embraced green bonds as part of its strategy to transition to a low-carbon economy. However, despite their potential benefits, India’s sovereign green bond market has struggled with weak investor demand. This article explores the concept of sovereign green bonds, their significance, and the reasons behind their limited traction in India.

What Are Sovereign Green Bonds?

• Green bonds are debt instruments issued by governments, corporations, or multilateral banks to raise capital exclusively for projects that promote environmental sustainability and reduce carbon emissions.
• These bonds typically offer a lower yield compared to conventional bonds, a phenomenon known as the “green premium” or “greenium.” This allows issuers to borrow at reduced costs.
• Sovereign Green Bonds (SGrBs) are green bonds issued by governments, such as the Government of India, to finance green projects.
• Investors in green bonds often seek long-term, stable returns and may have mandates requiring investments in sustainable finance.
• Despite their growing recognition, green bonds represent only a small fraction of the global debt market, as reporting standards and transparency mechanisms are still evolving.

Why Are Green Bonds Important?

• Sovereign Green Bonds play a critical role in supporting national sustainability goals and climate commitments.
• India introduced a framework for SGrBs in 2022, defining green projects as those that promote energy efficiency, carbon emission reduction, climate resilience, and ecosystem preservation.
• Since 2022-23, India has issued SGrBs eight times, raising approximately Rs 53,000 crore.
• A significant portion (50%) of the proceeds has been allocated to the Ministry of Railways for manufacturing energy-efficient three-phase electric locomotives.
• Other key allocations for 2024-25 include:
  • Rs 12,600 crore for electric locomotive manufacturing
  • Rs 8,000 crore for metro projects
  • Rs 4,607 crore for renewable energy projects, including the National Green Hydrogen Mission
  • Rs 124 crore for afforestation under the National Mission for a Green India

Why Is Investor Demand Weak for India’s Sovereign Green Bonds?

• Limited Greenium: While global green bonds achieve a greenium of 7-8 basis points, Indian SGrBs only fetch about 2-3 basis points, making them less attractive for investors.
• Liquidity Issues: The small issue sizes and the tendency of investors to hold bonds until maturity limit secondary market trading, reducing their appeal.
• Devolved Bonds: Recent auctions have seen limited participation, with a significant portion of bonds being devolved to primary dealers, indicating low demand.
• Foreign Investment Barriers: Although rules for foreign investors have been relaxed, participation remains tepid due to the absence of strong mandates for sustainable finance investments in India.
• Lack of Market Depth: Unlike advanced markets, India lacks a well-developed ecosystem of social impact funds and responsible investment mandates that typically drive demand for green bonds.
• Government Credit Rating: India’s sovereign credit rating is not as high as some advanced economies, making its green bonds less attractive to risk-averse investors.

Implications of Weak Demand

• The inability to generate substantial proceeds from SGrBs puts pressure on general government revenue to fill funding gaps.
• The original funding requirement from SGrBs for 2024-25 was Rs 32,061 crore, but due to weak demand, the revised estimate dropped to Rs 25,298 crore.
• A key casualty of this shortfall is grid-scale solar projects, where funding was slashed from Rs 10,000 crore to just Rs 1,300 crore.
• In the current fiscal year, total expected proceeds stand at Rs 21,697 crore, forcing the government to divert Rs 3,600 crore from its general revenue to cover deficits.

Potential Solutions to Boost Green Bond Demand

• Introducing Sustainability Bonds: A World Bank report suggests that emerging markets could benefit from sustainability bonds that combine green and social projects, potentially attracting more investors.
• Improving Transparency: Investors require detailed post-issuance allocation and impact reports to assess the usage of funds. India’s Department of Economic Affairs has yet to publish its report for 2023-24, affecting investor confidence.
• Partnering with Multilateral Development Banks: Collaborating with global financial institutions could help improve India’s green bonds’ credit rating, making them more attractive.
• Enhancing Liquidity: Increasing issue sizes and promoting secondary market trading could make SGrBs more appealing.
• Awareness and Incentives: Creating awareness about green investments and offering tax incentives or regulatory benefits could encourage greater participation from institutional and retail investors.

Conclusion

Sovereign Green Bonds are an essential tool for financing India’s green transition and meeting long-term climate commitments. However, their success depends on investor confidence, liquidity, and transparent reporting. Addressing these challenges through policy reforms, sustainability bond structures, and international partnerships could help India unlock the full potential of green finance. While the current demand is weak, strategic interventions can pave the way for a robust green bond market in India, supporting sustainable development and climate action.

Practice Question

Discuss the role of Sovereign Green Bonds in India’s transition to a low-carbon economy. What are the challenges in their implementation? (250 words)