Context:

India has adopted sovereign green bonds (SGrBs) as a key strategy to finance its transition to a low-carbon economy. However, these bonds have faced muted demand from investors, limiting the effectiveness of this funding source. Despite efforts to ease participation rules and attract foreign investors, the expected "greenium" (lower borrowing costs) remains weak, leading to funding shortfalls for vital green projects.

What are Sovereign Green Bonds?

Sovereign Green Bonds are issued by the government to raise capital for environmentally sustainable projects such as renewable energy, energy efficiency, and climate resilience. In India, the government established a framework for issuing these bonds in 2022. Since their introduction, India has raised nearly Rs 53,000 crore through eight issuances, with funds primarily allocated to projects like energy-efficient locomotives and metro developments.

Weak Investor Demand

Despite the government's efforts, India's SGrBs have struggled to attract investor interest. A significant issue is the limited greenium, which in India has only reached 2–3 basis points, far below the global average of 7–8 basis points. This lack of financial incentive makes these bonds less attractive compared to regular bonds. Additionally, small issue sizes and limited secondary market trading further discourage investors. Many bonds are held to maturity, stifling liquidity and market participation.

Impact on Green Initiatives

The weak demand for SGrBs has directly impacted the funding for critical green projects. Initially, India planned to raise Rs 32,061 crore from SGrB proceeds in 2024-25. However, after weak investor response, the revised estimate was reduced to Rs 25,298 crore, resulting in significant cuts to funding for projects such as grid-scale solar energy. The budget for grid-scale solar projects was slashed from Rs 10,000 crore to just Rs 1,300 crore. As a result, India is increasingly relying on general revenue to fill the funding gap.

Key Areas Affected by Funding Cuts

• Electric Locomotive Manufacturing: Rs 12,600 crore
• Metro Projects: Rs 8,000 crore
• Renewable Energy (including National Green Hydrogen Mission): Rs 4,607 crore
• Afforestation (National Mission for a Green India): Rs 124 crore

Challenges Contributing to Weak Demand

• Lack of Social Impact Funds: India lacks a robust ecosystem of social impact funds and responsible investment mandates, which are present in other markets and drive demand for green bonds.
• Liquidity Issues: Small bond issues and a lack of secondary market trading have made SGrBs less liquid and attractive to investors.
• Higher Yields in Other Investment Avenues: Investors are reluctant to accept the relatively low yields of SGrBs, as they offer little financial advantage over regular bonds.

Way Forward

To improve the attractiveness of SGrBs, India could explore the issuance of sustainability bonds, which fund both green and social projects, attracting a broader base of investors. Additionally, post-issuance transparency is crucial, with detailed allocation and impact reports needed to build investor confidence. The government can also collaborate with multilateral development banks like the World Bank to back its green bonds, enhancing their credibility and attracting investment.

Furthermore, enhancing liquidity and developing a more robust market for green finance are essential steps to ensure that India can achieve its climate goals. With proper strategy and structural changes, India can enhance investor confidence and ensure sustainable funding for its green initiatives.