Sovereign Green Bond: Why is its demand low in India?

Why in the NEWS?

• Green bonds in India are an important financial instrument for achieving clean energy and climate goals, but there are several challenges regarding its adoption and effectiveness.

Key Points:

• Green bonds are helping governments and companies around the world raise capital for clean energy and sustainable infrastructure.
• These financial instruments play a vital role in achieving environmental goals and tackling climate change.
• However, the green bond journey has not been easy for India.
• The country has struggled to achieve the low borrowing costs (called 'greenium') associated with these bonds.

What will you read next in this topic?

• A brief introduction of Bond.
• Credit quality.
• What are Green Bonds?
• What are Sovereign Green Bonds (SGrB)?
• Why is the demand for sovereign green bonds low in India?
• Effects of low demand for SGrB in India
• How can demand for green bonds be increased in India?

A brief introduction of Bond.

• Bonds are a type of fixed-income securities that governments, municipalities or companies issue to raise capital.
• Investors lend money to the borrower by buying bonds and receive interest (coupons) in return.
• There are several types of bonds, which may vary depending on their purpose, risk and return.

Key features of a bond

• Face value: The original price of the bond that is returned to investors at maturity.
• Coupon rate: The interest earned on the bond that investors receive periodically.
• Maturity period: The time after which the bondholder gets his entire principal back.

Types of bonds

• Fixed rate bonds: These have a fixed interest rate.
• Floating rate bonds: These have varying interest rates.
• Inflation-linked bonds: These are designed to reduce the effects of inflation.
• Perpetual bonds: These have no maturity period, and the issuer does not have to return the principal.

Who issues bonds?

• Government: The central and state governments issue government bonds to fund public projects, infrastructure and to meet fiscal deficits.
• Corporate Entities: Businesses issue corporate bonds to fund their expansion, research and development or other financial needs.
• Banks and Financial Institutions: Banks and other financial companies issue bonds to raise funds and expand their financial services.
• Municipalities: Local governments can issue municipal bonds to develop infrastructure and public services
• International Organizations: Institutions such as the World Bank, IMF issue bonds to provide financial assistance to developing countries.

Some specific types of bonds:

Government Bonds

• These bonds are issued by the government and are considered the safest investments.
• Sovereign bonds: Issued by the central government.
• State government bonds: Issued by state governments.
• In India, government bonds are issued by the Reserve Bank of India (RBI).

Municipal Bonds

• These bonds are issued by local municipalities or government institutions to raise funds for public projects (such as roads, schools, hospitals).

Corporate Bonds

• These bonds are issued by companies to raise capital for expanding business activities or for new projects.
• Secured Bonds: These bonds are issued against the company's assets.
• Unsecured Bonds: No assets are pledged for these bonds, so the risk is higher.
• Infrastructure companies often issue corporate bonds.

Green Bonds

• These bonds are specifically issued for environmental and climate-related projects (such as clean energy, water management).
• Their aim is to promote sustainable development and a low-carbon economy.

Convertible Bonds

• These bonds give investors the option to convert it into company shares in the future.
• Along with interest, one can also get the benefit of increase in shares.

Zero-Coupon Bonds

• These bonds do not pay regular interest, but are issued at a price lower than the face value and the full value is returned on maturity.

Inflation-Linked Bonds

• These bonds are linked to inflation, so the investor's return varies according to the rate of inflation.
• In India, Inflation-Indexed National Savings Securities (IINSS) are examples of this.

Perpetual Bonds

• These bonds never mature and investors continue to receive interest indefinitely.
• They are used for long-term investments.

Floating Rate Bonds

• The interest rate on these bonds changes from time to time according to market conditions.
• These bonds provide protection against fluctuations in interest rates.

Sukuk Bonds

• These are Islamic bonds, which are issued according to Sharia law. These provide income from assets instead of interest.
• Giving Muslim investors the option of investing according to religious rules.

High-Yield Bonds

• These bonds are issued by high-risk companies and have high interest rates.
• They have a high risk of default.

Social Bonds

• These bonds are issued to raise funds for social projects (such as education, health, housing).
• Their purpose is to promote the welfare of the society.

Special Purpose Bonds

• These bonds are issued for a specific project or purpose.
• Bonds issued for infrastructure projects are examples of this.

Credit quality

• The credit quality of a bond indicates how strong the issuer's financial position is and how capable it is of repaying its debts.
• Credit rating agencies assign ratings to bonds based on their safety.
• High-rated bonds (AAA, AA rating) are considered safe but have lower interest rates.
• Low-rated bonds (BB, B or lower) are more risky but offer higher interest rates.
• Investment grade bonds: These have a lower risk of default.
• Junk bonds: These have higher risk but can offer higher returns.

How do bonds work?

• When a company or government issues bonds, it borrows from investors and in return makes periodic interest payments to them.
• After the maturity period ends, investors are returned their full principal.
• The market value of a bond can change depending on interest rates, the issuer's credit rating and market conditions.

Benefits of Bonds

• Stability: Bonds are a safe investment option and provide fixed income.
• Legal Protection: Bondholders have a right to claim the company's assets before shareholders.
• Portfolio Diversification: It helps investors manage risk.

Limitations of Bonds

• Inflation Risk: If the inflation rate exceeds the bond's interest rate, investors may suffer losses.
• Limited Liquidity: Not all bonds can be easily bought or sold.
• Lower Returns: Bonds usually offer lower returns than stocks.

Things to consider before investing in bonds

• Investment objectives: Investors must decide for what purpose they are investing in bonds.
• Bond Duration: Long-term bonds offer higher interest rates, while short-term bonds offer more liquidity.
• Risk factor analysis: Investors should assess the issuer's credit rating and market conditions.
• Call risk: Some bond issuers may buy back bonds prematurely, causing losses to investors.

What are Green Bonds?

• Green bonds are debt instruments that governments, companies or multilateral banks issue to combat climate change and raise funds for green infrastructure.
• These are issued at a lower interest rate (greenium) than traditional bonds, thereby providing cheaper capital for green projects.
• Green bond investors expect long-term and stable returns.

What are Sovereign Green Bonds (SGrB)?

• These are green bonds that governments issue.
• India rolled out a framework for issuing Sovereign Green Bonds (SGrB) in 2022.
• Under this, the Indian government has raised Rs 53,000 crore till date from 2022-23.

Uses of funds raised from SGrB in India

• Railways: 50% of funds for energy-efficient electric locomotives.
• Metro projects: Rs 8,000 crore.
• Green Hydrogen Mission and Renewable Energy: Rs 4,607 crore.
• Forest Conservation (Green India Mission): Rs 124 crore.

Why is the demand for sovereign green bonds low in India?

Lack of Greenium:

• Globally, Greenium is up to 7-8 basis points, but in India it is limited to only 2-3 basis points.
• This does not give much benefit to investors, which reduces their interest.

Liquidity problem:

• Due to small issue size and investors holding bonds till maturity, there is less trading in the secondary market.
• This limits investor participation.

Lack of Social Impact Funds:

• Responsible investment and social impact funding models have not developed as much in India as they have in Western countries.

Problem of financial transparency:

• Investors need more transparency in the issuer's reporting system.
• India has not yet released the allocation report for 2023-24, which affects investor confidence.

Effects of low demand for SGrB in India

Cut in funding of green projects:

• The estimated funding requirement from SGRB for 2024-25 was Rs 32,061 crore, but it was reduced to Rs 25,298 crore due to fewer investors.
• Allocation for grid-scale solar projects was reduced from Rs 10,000 crore to Rs 1,300 crore.

Pressure on general revenue:

• The government had to draw Rs 3,600 crore from general revenue for green projects.
• How can demand for green bonds be increased in India?

Issuing Sustainability Bonds:

• Bonds that combine green and social projects may be more attractive to investors.

Providing more transparency to investors:

• Effective reporting of the use of green bonds and allocations should be published rapidly.

Partnerships with global financial institutions:

• India should partner with multilateral development banks (such as the World Bank) to ensure strong credit ratings for green bonds.

Providing more incentives to investors:

• The government should ease regulations for foreign investors.
• Tax benefits and other incentives should be offered on green bonds.