The government of India proposes to issue sovereign green bonds for the first time this year. The bonds will mobilise resources for green infrastructure which will be deployed in public sector projects for reducing carbon intensity of the economy.

Though the quantum of bonds and the markets and currencies in which they will be issued have not been announced, an amount of ₹24,000 crore has been reported. India is not new to green bonds, which have been issued by the corporate sector and banks.

So, is the move to issue sovereign bonds seeking to fill a gap in the market or is it just crowding out present market activities? Should the government focus instead on putting in place a policy framework, institutions and capacities to develop the market?

Global markets have been responding enthusiastically to the large requirements of green finance to reorient economic activities on a more sustainable basis. The Environmental, Social and Governance (ESG) funds are estimated at $40 trillion with Europe accounting for about half this. It is estimated that by 2025, ESG assets will account for about one-third of the total global assets under management.

The ESG debt funds pie is around $2 trillion, of which over 80 per cent is “environmental” or green bonds, and the rest social and sustainability bonds. Once again, Europe dominates in green issuances and Asia-Pacific has seen several pandemic-induced social or sustainability bonds. The first sovereign green bond was issued by Poland in 2016.

According to Climate Bonds Initiative, an international organisation working to mobilise global capital for climate action, Indian entities have issued green bonds for over $18 billion.

Green premium on bonds provides a yield discount of 10-20 basis points making them attractive. Green bonds are a voluntary capital market initiative to channel resources towards meeting the looming threat of climate change.

Green Bond Principles

The Zurich-headquartered International Capital Market Association has come up with a set of voluntary guidelines and criteria known as the Green Bond Principles (GBP). The principles cover use of proceeds, project evaluation and selection, management of proceeds and reporting. They provide for use of proceeds for projects in climate change mitigation and adaptation, conservation of natural resources and bio-diversity and pollution prevention and control.

The three leading user segments are energy, buildings and transport. National jurisdictions have notified their own guidelines, which are rapidly aligning with the GBP, including the circular issued by the Securities and Exchange Board of India (SEBI) in 2017.

The bonds can be issued in the domestic or international markets, and in the domestic or foreign currencies. Since the Budget announcement is silent on these aspects, they will be addressed before going to the market.

There are various considerations governing these choices. Bonds denominated in foreign currencies in international markets tap into the most liquid pool of capital and would, therefore, benefit from lower yield. However, they carry foreign exchange risk for issuers and a higher risk of default, particularly from fragile economies.

Domestic currency bonds in the international markets would address the currency risk problem for the issuer, but would be a hard sell until the appetite for such bonds in the international centres of finance is developed. That is the incentive for countries to develop such markets. Rupee denominated bonds of this kind are called masala bonds of which there has not been a sovereign issue so far. The last option is to issue domestic bonds in the domestic market, which, in case of a sovereign, are immune from default because of the ability to print money but the disadvantage is that the pool of capital is not enlarged.

Masala bonds, the best option

Considering these factors, and taking into account the fate of an earlier announced issue of dollar denominated sovereign bonds, it would appear that masala green bonds are the best option.

However, since there has not been any issue of sovereign masala bonds, what will be benchmark for the green issue? Should that benchmark not be developed first to know and tap the green premium? At the same time, the government and its agencies can take several policy, regulatory and developmental steps to improve the opportunities for green and sustainable investing.

The government should have a policy on sovereign green bonds covering considerations for the choice of currency and markets, guarantees and credit enhancements, priorities on use of proceeds, project or sector selection, absorptive capacity development including aspects of disclosure, reporting, monitoring and verification. This would entail creating a separate green bond accounting framework for the management of proceeds. Green bonds have much larger and non-financial disclosure, reporting and verification requirements than regular bonds.

Yet, the regulatory approach to issue of green bonds, both in India and abroad, seems to rely essentially only on the issuer and traditional capital market intermediaries. It raises issues of both expertise and incentives and the spectre of greenwashing.

To address this concern, the policy should directly provide a role for reputed green actors such as institutions and research centres in identified green use sectors as registered capital market intermediaries either alone or in association with traditional intermediaries. They can play credible roles in the disclosure, reporting, verification and impact assessment processes, thereby improving market efficiency.

Further, to deepen the reach of green finance there is a need to develop capacity in smaller firms and the unorganised sector to be eligible users, for which a programme should be launched, ideally in association with international stakeholders under the Paris Agreement.

The writer is a Distinguished Fellow at The Energy and Resources Institute (TERI), and former Secretary, Department of Heavy Industry

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