Decoded: What are green bonds and how much will be the govt issue?

For the first time ever, the government will this year embark on the issuance of green bonds, Finance Minister Nirmala Sitharaman said while presenting the Union Budget in February. The move comes amid an increased global push towards setting aside funds, both private and public, for environment-conscious development. However, the success of the government’s plan to introduce bonds specifically aimed at raising funds towards this end is contingent on the creation of a conducive investment climate. We decode the proposal to launch green bonds.

What are green bonds?

Green bonds are debt instruments the proceeds of which are utilised to finance projects that are beneficial to the environment. The features of these instruments are similar to other fixed-income securities, with the only distinguishing aspect being that the funds raised are exclusively used for sectors such as renewable energy.

At an international level, green bonds were first issued in 2007. Global accords such as the Paris Agreement have given a fillip to environmentally-conscious financing and so far, a large part of the global demand for green bonds has been driven by segments such as insurance and pension funds.

As global ESG (environmental, social, governance) norms become more stringent, Indian corporate entities have been joining the global brigade, with domestic firms issuing more than $6 billion of such instruments in 2021, treasury officials said.

When and how much will be the government issue?

“As a part of the government’s overall market borrowings in 2022-23, sovereign green bonds will be issued for mobilising resources for green infrastructure. The proceeds will be deployed in public sector projects which help in reducing the carbon intensity of the economy,” the Budget speech read.

Given that the Centre’s debt issuances in the first six months of the year did not include sales of green bonds, these instruments are set to be launched in October-March. According to reports, the government is likely to test the waters for green bonds with small issuances worth a total of around Rs 20,000 crore to Rs 25,000 crore. The Centre’s overall market borrowing for the current fiscal year has been scheduled at Rs 14.3 trillion of which close to Rs 6 trillion is left over the next six months.

Given that the government has not yet specified the modalities of the green bond issuance, bankers await more clarity.

“The response depends on the pricing that comes in for the green bonds. If the government is planning to invest that money into the energy-saving sector or in the creation of renewable energy sources, I think banks would be happy to invest, because banks will also have to build a green book. They are also looking at ESG commitments and moves in that direction,” said Ashutosh Khajuria, executive director, Federal Bank.

Challenges in implementation

The topic of pricing brings to what is potentially the key hurdle for the acceptance of green bonds in the currently nascent Indian market for these instruments, especially in the absence of an established ecosystem of foreign investment.

Globally, green bonds are issued at a premium to other kinds of debt, as the instruments, by design, are meant to facilitate access to cheaper capital for environment-friendly projects. What this means is that the rate of interest offered by green bonds to investors is lower than other debt instruments.

Furthermore, such bonds issued by governments would hypothetically carry an even greater premium – or lower interest rate – as sovereign borrowing is considered to be bereft of risk.

“There has to be an entire ecology around it. You get an advantage when you issue green bonds because you receive lower cost of financing as compared to regular bonds. This happens because there are philanthropic investment funds etc that are focused entirely on green bonds,” said Vikas Goyal, MD and CEO, PNB Gilts.

“Now, they are willing to accept a lower return because they are also driven by altruistic reasons. The problem in India is that there is no investor universe,” he said. “Right now, the foreign funds that buy these bonds globally are not really there in India. A domestic investor may be reluctant to accept a lower return.”

Ways to increase appeal

If one were to go by the rising global emphasis on shifting to environment-conscious development, the likelihood of the government progressively increasing the share of green debt issuances is strong.

Reports earlier this week said that the government is fleshing out methods to convince investors that the funds raised via green bonds would not be utilised for projects other than those that are environmentally friendly. The matter was said to have been brought about by the Singapore administration, the reports said.

Apart from making the investment climate more conducive for foreign entities by exploring the option of listing Indian debt on global ‘green’ indices as well as identifying foreign funds willing to accept lower returns, there are other ways in which the government could incentivise investors.

“The other way is to give an incentive to banks and other investors – maybe something like an increased weightage on LCR (Liquidity Coverage Ratio),” Goyal said. “Then banks will automatically buy green bonds. Or lower taxation, for instance, whatever is the marginal tax, the income from a green bond could be taxed at 25 per cent instead of 30 per cent.”