Sovereign Green Bonds, Purpose, Advantages and Challenges

Context: India’s SGrB issues have faced challenges in gaining investor interest, making it hard for the government to secure a greenium.

What is Sovereign Green Bonds?

• Sovereign Green Bonds (SGrBs) are debt instruments issued by governments to raise funds for projects aimed at reducing emissions and enhancing climate resilience.
• India has issued SGrBs eight times since 2022-23, raising nearly Rs 53,000 crore in total.
• The government uses around 50% of the funds raised from SGrBs for energy-efficient projects, such as the production of electric locomotives under the Ministry of Railways.

Working Mechanism of SGrBs

Purpose of Sovereign Green Bonds

• Green bonds are bonds issued by a sovereign entity, inter-governmental groups alliances and corporations with the aim that the proceeds of the bonds are utilised for projects classified as environmentally sustainable.
• These Green Bonds have emerged as an important financial instrument to deal with the threats of climate change, as they connect environmental projects with capital markets and investors and channel capital towards sustainable development.
• Purpose: SGrBs are government debt instruments specifically designed to finance projects that contribute to India’s transition to a low-carbon economy.
• Net-Zero Goals: SGrBs play a vital role in funding initiatives aligned with India’s ambitious net-zero emissions goals, including sourcing 50% of energy from non-fossil fuel sources and reducing carbon intensity by 45%.
• Oversubscribed Tranches: In January and February last year, the Reserve Bank of India (RBI) issued SGrBs worth ₹16,000 crore in two tranches. Despite being oversubscribed, the participation primarily comprised domestic financial institutions and banks.

Framework for Issuance of SGrBs in India

• The framework draws from the International Capital Market Association’s (ICMA) Green Bond Principles, which provide principles of voluntary best practice guidance on the use of proceeds, the process for project evaluation and selection, management of proceeds and reporting.
• The Ministry of Finance has constituted a Green Finance Working Committee (GFWC) to facilitate the process of project evaluation and selection.
• The funds raised through the issuance of green bonds will be deposited in the Consolidated Fund of India (CFI).
• Further, the Public Debt Management Cell (PDMC) will keep track of proceeds and monitor the allocation of funds towards eligible green expenditures.

Advantages of Sovereign Green Bonds

• Security: Being government-issued, these bonds offer minimal risk of credit default, making them a secure investment option.
• Sustainable Investment: They provide an opportunity for investors interested in contributing to sustainable and environmentally friendly initiatives.
• Risk-Free Projects: Investors in Sovereign Green Bonds are insulated from risks associated with the financed projects since repayments of principal and interest are guaranteed regardless of project outcomes.

Risks Involved with Sovereign Green Bonds

• Potential for Greenwashing: There’s a concern that the environmental benefits promised by projects funded through these bonds might be overstated or misrepresented.
• Credit Rating Sensitivity: For governments seeking international investors, the attractiveness of these bonds is heavily influenced by the country’s credit rating, which reflects the overall risk of investing in such bonds.

Role of Foreign Institutional Investors (FIIs)

• Widening Capital Pool: Allowing FIIs to invest in India’s green projects expands the capital available for funding the country’s sustainability goals.
• Interest in Diversification: FIIs are seeking to diversify their green investments, attracted by regulatory support and opportunities in emerging markets like India.
• Addressing Greenwashing Concerns: India’s Sovereign Green Bonds Framework, introduced in 2022, addresses greenwashing fears and provides FIIs with credible investment opportunities.

Challenges with India’s Sovereign Green Bond (SGrB) Market

Lack of Investor Demand

Lower Greenium in India. Globally, green bonds can secure a greenium of 7-8 basis points, but in India, it has often been just 2–3 basis points.

• Greenium refers to the savings an issuer of a green bond realises on the associated coupon payment because the bond is green.
• It is the amount by which the yield on the green bond is lower, compared with the conventional bond.

Liquidity Issues

• Small issue sizes and the tendency for investors to hold the bonds until maturity have stifled secondary market trading.
• Without a vibrant secondary market, SGrBs lose out on one of the advantages of conventional bonds — the ability to trade and access liquidity.

Lack of a Robust Ecosystem for Green Investments

• India lacks a strong ecosystem for social impact funds and responsible investing mandates.

Post-Issuance Transparency Issues

• Lack of transparency around how the funds raised from green bonds are being used has affected investor confidence.
• India’s Department of Economic Affairs has not yet released the allocation and impact report for 2023-24, which provides essential information to investors. This delays assessments of how funds are utilized and limits investor trust.

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