What are green bonds? How can they achieve 2022 RE targets

In June 2015, the Indian government reaffirmed its support to renewable energy (RE) suppliers by revising the generation capacity to 175 GW by 2022. Of this, 100 GW is slated to come from solar, 60 GW from wind, 10 GW from biomass and 5 GW from small hydro projects.

Given the fact that India's cumulative RE capacity grew by only 29 GW from 2007 to 2015 (CSE, India), achieving an additional capacity of around 136 GW in the next seven years seems to be a monumental challenge in the absence of favourable financing conditions.

Until now, the RE sector has relied heavily on sponsor equity and conventional lending channels for meeting its capital requirements. According to media sources, the target of 175 GW will need investments of $200 billion. However, banks have traditionally given priority to investing in more reliable thermal power projects over RE projects.

This raises two questions:

1) Will traditional lending channels such as commercial banks and public financial institutions (PFIs) be able to support this debt requirement over the next seven years?

2) Where is the large sum of money needed to fund such a sudden RE capacity-building exercise going to come from?

Conventional financing mechanisms may fall short for RE projects in India. These projects have higher initial investment requirements, longer payback periods and lower rates of return. To make large-scale RE projects attractive for developers, access to long-term loans with appropriate interest rates is essential. To ease the pressure on the cash-strapped RE sector, a financing scheme with longer tenure and lower interest rate needs to be floated.

Snapshots of governmental sources of funding

Currently, funds allotted to the Indian Renewable Energy Development Agency (IREDA) by the central government and the cess collected by the National Clean Energy Fund (NCEF) are the only two sources of funds that help the Indian government execute RE projects.

According to IREDA CMD K.S. Popli IREDA has finalised agreements for raising Rs.15,700 crore (over $2 billion) from various international funding agencies and banks to achieve the 2022 targets. In March 2015, the government agreed to keep aside Rs.2,680 crore annually to fund RE projects and minimise funding concerns. In addition, NCEF collects a cess annually and generated Rs.16,388 crore in 2014 and Rs.13,118 crore in 2015 (an average of Rs.14,753 crore per annum).

Assuming that NCEF continues to collect this average amount for the next seven years and IREDA and the government release the money as expected, the government will only have approximately $38 billion at its disposal. The country will still need to formulate a strategy to raise the outstanding $162 billion.

In an attempt to attract domestic commercial banks to fund RE projects, the Reserve Bank of India (RBI), in April 2015, revised the priority sector lending guidelines by including RE as a priority sector for banks.

This move was widely appreciated by developers and is expected to compel domestic and foreign banks (with more than 20 branches) to invest a portion of their credit in RE projects. One way for banks to avoid the RBI ruling from affecting their ongoing fund deployment and create new wealth pools for dedicated RE loans is through raising new funds by issuing green bonds.

What are green bonds?

Green bonds are standard fixed-income financial instruments where the proceeds are exclusively utilised for financing climate change related projects/programmes. They are an attractive instrument for both private and public sector organisations to raise capital for projects that benefit the environment and society.

In February 2015, YES Bank kick-started India's green infrastructure bond market by issuing the country's first green infrastructure bond of $160 million. The proceeds from this fund are expected to be only poured into RE projects. This issue was oversubscribed by two times.

Similarly, in March 2015, the Exim Bank of India issued a five-year $500 million green bond - India's first dollar-denominated green bond that was oversubscribed by 3.2 times. Both these bond issues reflect the faith and appetite of Indian investors for realising a carbon-free economy.

Assurance Mechanisms

Once banks have raised the capital through green bonds, they need to ensure that their investment activities are disclosed as per the norms introduced by SEBI in December 2015. These provide disclosure requirements by the companies intending to issue green bonds and demand periodic reporting of fund allocations.

These norms will ensure that banks and other commercial financial institutions invest in projects that have minimal impact on the ecosystem. In the larger interest of public disclosure, SEBI mandates the inclusion of an annual business responsibility report (ABRR) as part of the annual reports for top 100 listed companies. The ABRR of an institution is expected to disclose ongoing welfare activities and quantifiable benefits that ascended from efforts undertaken for social or environmental welfare in a given financial year.

To assure investors of their commitment towards carbon-free projects, lending institutions could hire third party auditors that appraise projects on a regular basis. A summary of the environmental impact of these projects could be featured in the ABRR on a regular basis.

Given the dire need for low-cost financing in the country, other banks and public sector utilities should consider raising funds through green bonds as they will definitely help expedite infrastructure development activities and further India's objective of realising a low-carbon economy.

By Ashish Nigam

(The author is a research engineer at the Center for Study of Science, Technology and Policy (CSTEP), Bengaluru. The views expressed are those of CSTEP. The author can be contacted at [email protected])