Green taxonomy urgently needs green capital for India's net-zero ambitions

India's Climate Finance Taxonomy can define green activities, but affordable capital for MSMEs will determine whether the country's green transition succeeds

India’s proposed Climate Finance Taxonomy will bring clarity to what qualifies as a green economic activity and provide a credible framework for channelling sustainable finance. But classification alone will not accelerate India’s green transition. The real challenge is ensuring that affordable capital reaches the millions of micro, small and medium enterprises (MSMEs). 

India’s net-zero aspirations cannot be realised solely through large renewable energy projects, electric mobility or green infrastructure. With over 86 million registered MSMEs contributing nearly 30 per cent of gross domestic product (GDP) and close to 45 per cent of manufacturing output, this sector is central to our climate strategy. 

Encouragingly, the draft taxonomy acknowledges this reality by proposing simplified eligibility and reporting requirements for smaller businesses. However, it leaves one fundamental question unanswered: How will these enterprises access affordable green finance? 

For an MSME entrepreneur, sustainability is rarely an environmental choice alone. It is a business decision. Investments happen when they improve productivity, reduce operating costs, enhance competitiveness and generate an acceptable financial return. If financing a green asset costs no less than a conventional one, adoption will inevitably be slower, irrespective of how well the activity is classified. 

This is where the green finance framework must evolve. A taxonomy creates confidence and transparency. It tells investors and lenders what qualifies as green. But it does not lower the cost of capital. 

From a lender’s perspective, green finance presents its own challenges. Assessing climate-friendly projects often requires additional technical evaluation, verification and monitoring. Loan sizes, particularly in the MSME segment, are relatively small while acquisition and servicing costs remain high. 

Yet the lender’s cost of funds remains largely unchanged, and, in many cases, the underlying credit risk is not materially different from conventional lending. Without access to lower-cost sources of capital, green lending becomes commercially difficult to scale. 

Global experience reinforces this point. Countries that have built successful green finance ecosystems have done much more than publish taxonomies. Germany’s KfW, Japan’s development finance institutions and several European blended finance programmes demonstrate that classification frameworks become effective only when supported by concessional pools of capital that reduce borrowing costs for end users. 

India has already laid a strong policy foundation through the Sovereign Green Bond Framework, the Reserve Bank of India’s (RBI’s) Green Deposit Framework and climate-risk guidance for regulated entities along with the Securities and Exchange Board of India’s (Sebi’s) sustainability disclosure architecture. The Climate Finance Taxonomy is the logical next step. But if India wants green investments to move beyond policy intent and become commercial reality, it now needs a complementary financing architecture. 

Development finance institutions can play a catalytic role by creating dedicated refinance windows for taxonomy-compliant MSME lending. Providing lower-cost wholesale funding to banks and non-banking financial companies (NBFCs) would enable them to pass on the benefit to borrowers without distorting market pricing. Additional measures such as targeted credit guarantees, concessional hedging support for climate-linked foreign borrowings and digital registries for green assets would further strengthen the ecosystem. 

NBFCs will have an especially important role in this transition. Their technology-driven underwriting models, deep understanding of local markets and ability to serve smaller enterprises position them uniquely to finance green investments beyond metropolitan India. While banks will naturally lead the financing of large infrastructure projects, NBFCs can become the principal conduit through which affordable green finance reaches millions of entrepreneurs across the country. 

India’s green transition will not be won in conference halls or policy documents. It will be won through millions of investment decisions taken by small businesses every single day. The Climate Finance Taxonomy provides the roadmap. The next policy imperative is to ensure that affordable capital follows that roadmap. Green taxonomy without green capital will remain an exercise in classification. Combined with a robust refinance architecture, however, it can become one of the most powerful catalysts of India’s sustainable and inclusive economic growth.

The writer is founder and MD, UGRO Capital