The Budget has an interesting announcement in the area of sovereign green bonds. A green bond, simply put, is like any other debt instrument, except that the proceeds are used to fund projects which are environmentally compliant. There have been some, though limited, issuances in the private sector.
A government coming up with such a bond in India will be novel given that ‘environment’ and ‘greening are catch phrases today. In fact, if successful, States too will be able to do the same, as the goal is common.
As a corollary, as the market evolves, the corporate ‘green bond’ market will also develop as there are several investors who take decisions based on fulfilment of this objective. The details will be spelled out in course of time, but it would be interesting to conjecture on the form it will take.
The government has a gross borrowing programme of around ₹14.95-lakh crore. It seems that, to begin with, around 5 per cent could be targeted as sovereign green bonds. These bonds when raised will be used exclusively to fund projects which have something green about them.
If one looks at the capex of ₹7.5-lakh crore, around 65 per cent is devoted to roads, railways and defence. Essentially, the government either buys machinery from private players or gives contracts to private or public companies if they are in projects like roads. Normally, funds are fungible and it may be hard to determine how they are utilised.
But in this case there will be earmarking of the amount raised to specific targeted projects. Therefore, the crux is that the recipients of such funds should be complaint. This is where certification is required, and the onus will be on the company to prove that the norms have been followed. How this certification can be obtained has not been formalised so far; hence, there could be some ambiguity here.
Being green is a fuzzy concept and it ends up with companies trying to tick several boxes to show they are compliant. Besides, monitoring can also be an issue as companies could be compliant at the time of such certification, but less so subsequently. There would be a challenge with respect to monitoring how this green grading performs.
A power or road project that is declared green should ideally not be flouting the norms, but the larger question is who will monitor the same. This will be a challenge until such time the system of evaluation is streamlined as deviations from the norm are hard to capture.
Next would be the pricing of these bonds. Should they be lower than the regular bond or higher? There has to be a difference. Otherwise the idea would be vitiated. Ideally, it needs to be higher; this is because investors need to be rewarded for choosing to promote ESG goals. Therefore it can be, say, 10-25 basis points (bps) higher than the normal yield on a bond. On the other side it can be argued that the rates can be lower than normal because investors like to reward green projects, anyway.
Besides, lower rates would make green bonds viable for corporates and project developers. Hence, it needs to be seen as to how the pricing system evolves amidst these forces.
On the demand side, who would typically buy these bonds? If the rates are higher, it would be universally attractive. Else, there may not be much interest among investors, unless banks, mutual funds and pension funds have back-end commitments for lending or investing in green-friendly bonds. Or, as mentioned earlier, there could a group of environment-oriented investors (not too many in India today).
The regulators would have to discuss among themselves whether there should be a special dispensation for green bonds to make them attractive. A way out would be to launch them as tax-free bonds with a yield of, say, 7 per cent for 10 years as this appears to be the likely rate for government bonds of similar maturity.
This will evince a lot of interest especially at the retail end. Funds can be locked in for a long tenure and the government can procure the same without putting pressure on the bond market. This will be a win-win situation for all parties concerned.
The option of launching them overseas is tempting. Here there can be a choice between masala bonds where they are issued in rupees. The Indian community may be interested if the returns are good and would be constantly weighing them relative to the interest on NRI deposits. But here the government will have to bear the forex risk which may not be acceptable. Masala bonds are attractive for investors because they are free of forex risk.
If the bonds are issued in foreign currency, foreign funds could evince interest. ESG is a big theme globally; there are several funds which invest in ESG compliant stocks or bonds. Coming from a sovereign, such bonds will carry credibility. The downside is that once the government goes global, then credit rating will matter a lot as all bonds issued globally need to be rated by the Big Three.
Are we prepared for this? The downside is that once one is rated by them, there is constant scrutiny on domestic policies. Presently, this does not matter because the government of India does not borrow from the overseas market. The rating given of BBB- is clearly out of sync with the strengths of the economy and this is an argument that has been reiterated by several analysts and economists.
Under these circumstances, it is reasonable to expect that these bonds will be issued only within the country. The overseas option would not be on until we are at ease with the idea at a policy and ideological level.
The writer is Chief Economist, Bank of Baroda, and author of ‘Hits & Misses: The Indian Banking Story’. Views are personal