Unlocking Climate Finance: How Capital Markets Can Drive India’s Green Transition

Despite the global acknowledgement of climate change, there has been a significant lag in the financial and technical support promised by developed countries to developing nations. These delays worsen as extreme weather conditions intensify, disproportionately affecting vulnerable developing countries. India, with a population of 1.4 billion and a per capita income of around USD 2,500, is particularly vulnerable. Although India’s per capita emissions remain relatively low at 1.6 metric tons of carbon dioxide equivalent (CO2e), it remains the third-largest annual emitter globally. India has set ambitious climate goals, including reducing its emissions intensity by 45% by 2030 and reaching net-zero emissions by 2070, but faces significant challenges in terms of financing these efforts. Estimates suggest India will require an average of USD 100 billion annually until 2030 to meet its international commitments, while current funding is only USD 44 billion per year.

Sources of Climate Finance in India

Currently, India’s climate finance primarily comes from development finance institutions (DFIs), public sector undertakings (PSUs), commercial financial institutions, and government budgets. DFIs face limitations due to competing infrastructure needs, while the government and PSUs face fiscal constraints. Consequently, private and international investments are needed to fill the gap. A granular analysis of sector-specific funding needs is essential to make projects investable, particularly in hard-to-abate sectors like steel, cement, and thermal power. For example, India’s steel sector aims to reduce emissions from 2.5 metric tons of CO2e per ton of steel to 1.6 metric tons by 2030.

India’s Carbon Credit Trading Scheme

In June 2023, the Indian government introduced the Carbon Credit Trading Scheme (CCTS), which allows entities that surpass their emission reduction targets to sell carbon credits to those that fall short. This system incentivizes companies to adopt cost-effective measures to reduce emissions and create a transparent domestic carbon credit market. The framework needs to be operationalized quickly to allow firms to meet their targets and raise the necessary transition finance. The success of this scheme will largely depend on a clear regulatory framework and well-structured projects.

Demand and Supply of Green and Transition Finance

India needs to identify investible green projects, segregating them from those requiring government intervention to reduce risks. Although ESG (Environmental, Social, and Governance) investments have gained momentum globally, they remain underdeveloped in India. In the fiscal year 2022-23, the Indian government raised INR 160 billion (USD 1.91 billion) through sovereign green bonds (SGBs). While the demand for these bonds has been modest, the issuance of SGBs is expected to encourage further investments in green projects. India’s ESG-themed mutual funds are also on the rise, but their overall success remains limited, with assets under management of INR 100 billion (USD 1.19 billion) as of March 2023.

The Role of the Indian Capital Market

India’s capital market plays a pivotal role in financing green projects. With a total market capitalization of 120% of GDP in 2023, India’s capital market is well-regulated and resilient. For instance, the NIFTY 50 delivered a return of 19.42% until January 2024 despite global economic shocks. SEBI has established robust reporting guidelines through the Business Responsibility and Sustainability Report (BRSR), encouraging transparency and enhancing investor confidence. Private equity investments in green projects can be facilitated through alternate investment funds, although the cumulative funds raised by social impact funds remain low at INR 6.41 billion (USD 0.07 billion).

Challenges in the Corporate Bond Market

India’s corporate bond market, a critical channel for raising green finance, remains underdeveloped, especially for long-term projects like green infrastructure. Debt instruments currently account for 45% of climate finance, but this figure is expected to rise. To improve the depth and liquidity of the bond market, the government must develop a clear taxonomy for what constitutes a “green” investment. Collaboration between SEBI, the Reserve Bank of India (RBI), and other stakeholders is crucial to attract foreign investment, especially in long-term projects.

Conclusion

India faces a significant challenge in meeting its climate financing needs by 2030, with an estimated two-thirds of funding likely to come from international sources. A more systematic, granular assessment of sector-specific funding needs is essential. While India’s capital market shows promise, significant regulatory and policy interventions will be required to make climate finance successful. Government support will be necessary for less investible projects, and enhancing the corporate bond market is crucial for long-term, sustainable financing.

The article below is based on the detailed analysis provided in the report “The Role of Capital Markets for Raising Green and Transition Finance” by Ajay Tyagi and Rachana Baid published by the Observer Research Foundation.