Comment: Enablers and detractors of transition finance, an India perspective

Not long ago, $1 trillion in annual global climate investments was the goal. We have now reached that milestone.

The transition is accelerating globally, including in India. India’s present day transition vocabulary includes green infrastructure, a sizeable transition-focused industrial policy tool box, and the capability for new financial instruments.

From an emerging markets perspective, the risk of being locked-in a high carbon future is concerning, considering India pegging for an advanced economy status by 2047.

India’s approach to energy transition and the challenge of mobilising transition finance are distinct due to the variation in landforms, populations and scales.

To reach 500GW of renewable energy capacity and reduce the emission intensity of the economy by 45 percent by 2030, India needs to increase the rate of capacity additions significantly.

This will require tripling energy investments each year. Innovative financial instruments will be essential to bridge this funding gap. While policymakers recognise the need for trillions in financing, an economically coherent program to mobilise these funds is still lacking.

Earlier this month, the Reserve Bank of India (RBI) cancelled the sale of 10-year green bonds due to traders’ reluctance to pay a greenium and anticipated election-related volatility. Interestingly, a similar occurrence caused the French SFIL to delay the sale of a green bond.

With the elections behind us, and India’s clean industrial initiatives emphasising energy independence through mega solar and wind parks, green energy corridors, nuclear energy production, and large-scale battery energy storage systems, one can’t help but wonder if India’s energy transition can be accelerated at scale.

In the light of central bank divergences, and the criticism of central banks supervisory expectations proxying as climate policymakers, the RBI’s stance has been encouraging. With an ambitious set of proposed disclosures on climate risks the RBI has set the tone on the governance of climate-related financial risks.

More recently, the bank authorities highlighted that they are focused on initiatives like sovereign green bonds, assessing the impact of climate change on default risk, and creating contingency plans for extreme climate events through actuarial analysis.

They are also examining suitable coverage for green deposits, climate risk-based differential premiums, and determining the ex ante funding requirements for climate funding.

Nevertheless, it will be interesting to observe when and how a future transition finance mandate impacts its regulated entities.

Notably, a coal phase-out may be on the cards only beyond 2040 according to a government think-tank study.

The ongoing changes in the energy economy could have adverse livelihood and energy security impacts in eight states in the northern and eastern regions of the country, which face significant economic challenges.

And so, the transition finance for emerging markets must be assessed from an embedded climate framing. That is, new social imaginaries of the transition should not be considered solely from a co-benefit perspective but must be treated as equally fundamental as environmental impacts.

Taxonomy and JETPs

The potential frameworks that could facilitate, bolster, and channel funds toward this integrated transition include the much-awaited India taxonomy and the possibility of a methodically negotiated Just Energy Transition Partnership (JETP).

In the consideration of a taxonomy, policymakers in India need to have adopted a socially conscious transition lens to facilitate increased investor confidence, attracting investors seeking sustainable investment opportunities. The characteristic ambiguity of the transition finance is apparent.

For instance, some of the major players in India energy transition are the legacy fossil fuel utility companies. They are diversifying their business models towards new technologies and could become the primary recipients of transition finance.

For the Indian taxonomy to be truly innovative, it needs to clearly define a comparable “use of proceeds” concept or set outcomes-based incentives.

This will help avoid unintentionally supporting the funding of companies that are slow to transition or that may be exposed to social risks, such as those involved in mining critical minerals for the new energy economy.

The taxonomy criteria should be clearly defined, inclusive, locally relevant, and ambitious, facilitating cross-border investments.

They must ensure transparency, maintain integrity through independent processes, and provide regulatory clarity from the start.

The taxonomy can spur the development of financial products, such as transition bonds or policy-based guarantees, sustainability-linked loans, climate-resilience based debt, and green insurance products with greater confidence.

It can attract both domestic and international investors seeking sustainable investment opportunities, enhancing the flow of capital into transition projects.

According to experts involved in its development, India has drafted its taxonomy but has yet to release it.

Transition plans and capital allocation

More than 90 Indian listed companies have committed to long-term decarbonisation targets. Among them, 28 percent plan to achieve these targets before 2050, and a similar percentage belong to the hard-to-abate sector.

A well-executed, high-integrity transition finance strategy can ensure that genuine climate leaders benefit, including by receiving a lower cost of capital.

In order for transition finance to represent the multi-trillion opportunity that it is for bond investors the companies need to enhance the credibility of their transition plans.

For example, common gaps in transition plans typically include alignment with credible sector pathways, adherence to the mitigation hierarchy, inclusion of value chain emissions in targets, transparent capex plans, and elaborate product-linked decarbonisation strategies.

Equity investors are likely to find new opportunities in in sustainable companies and technologies, while bond investors will benefit from the stability and diversification offered by green bonds, sovereign bonds, sustainability –linked bonds and better risk management practices.

Overall, the primary usefulness of transition finance lies in facilitating an orderly transition to net zero by avoiding capital misallocation.

As India strides towards its ambitious decarbonisation goals, the future of transition finance holds immense promise and complexity.

The road ahead will require not only a robust framework of policies and financial instruments but also a deep integration of social and environmental considerations.

The forthcoming India taxonomy and potential JETP will play critical roles in defining and steering these efforts.

With a dynamic approach, India can harness transition finance to drive a sustainable and inclusive energy transition. However, addressing high financing costs, ensuring the credibility of corporate transition plans, and maintaining investor confidence will be pivotal.

By overcoming these challenges, India can position itself as a leader in transition financing and a scaled orderly transition.

Since this article was written, the IFSCA Report on Transition Finance by the Expert Committee on Climate Finance has been published. The report outlines a possible definition of transition finance in the Indian context as well as new instruments and strategies for mobilising financial resources to support India’s transition to a low-carbon economy. It highlights the importance of aligning financial flows with climate goals and addresses challenges in scaling up climate finance and regulatory frameworks to facilitate the transition.

Chaitra Nayak is a senior manager equity investments ESG at DSP Asset Managers.