Mispricing the economic costs of climate change has huge implications, and Neha Kumar of the Climate Bonds Initiative explains all things green finance
A shepherd herding his goats past the wind turbines. Kanyakumari, India [image by: Braden Gunem]
One of the things that people talk about when they speak about India’s green transition is the issue of money. We hear about how much it will cost, who will fund it, what its profitability will be, and why it constrains the decisions we can or cannot take. At its most basic level, though, money is only a form of consensus, what we have agreed on as a measure of value. Things cost more or less depending on the supply and demand of a good. Some prices are “stickier” – reflecting a deeper and more entrenched understanding of its value – while others are less so. For example, an ounce is gold is not likely to change its price by too much over five years, but an iPhone changes its value in a few months depending on whether a new model has been released or not.
One of the challenges with climate change is that we are completely confused about the price of things. How do we calculate how much a tonne of carbon dioxide is worth, given that it is a primary cause of global warming? Bear in mind that this is not an impossible measurement. The World Meteorological Organization just released its State of the Climate in Asia, 2020, report. In it, it estimates that the costs of extreme weather events – cyclones, floods, and droughts – cost India USD 87 billion in 2020. We could, potentially, break this number down and allocate a share to the producers, suppliers, and consumers of goods that produce CO2. It would be an enormously complex exercise, but no more complex than how we allocate taxes and profits from a mobile phone sold at the local corner shop.
This means that things are mispriced. The key role of money as a bearer of information is corrupted.
Since we are not factoring in the eventual price that people will pay (in terms of sea rise, displacement, disasters, and all the rest) the cost of something we buy is deceptively low – deceptively, because those costs will still come due. We will pay for them in another way.
This is the equivalent of somebody selling you a T-shirt for 30 rupees that is likely to give you a skin infection that will cost you another 500 rupees for a doctor’s consultation and then another 100 rupees for medication to deal with the rash.
In an important way what the climate crisis is, is an accounting fraud. By shoving the eventual cost of the goods we are producing on the general public – quite often the poorer section – people are making a large profit by discounting the costs. In very real terms they are making a killing.
This is also one of the reasons why, despite the consistent scientific consensus around the human causes of climate change, there has been a great deal of confusion on its causes in the public domain. People making obscene profits from this accounting fraud do not want their profits to come down, and can afford to pay to confuse the public, and to lobby politicians to go slow, or deny the real costs.
As Neha Kumar explains in her interview this fortnight, capital markets work when money is clearly able to understand the metrics.
Where there is confusion, money will not move, or will move in contradictory directions.
This comes back to what we talk about when we talk about the money needed and that could be made from India’s green transition. Money, in the end, is composed out of millions – even billions – of tiny inputs that represent the value of what we are trying to do. In general, what people want is a better life – quicker transport, warmth in the winter, cool in the summer, tasty food, an enjoyment of life, comfort, etc. What we are unable to communicate clearly is what that better life is for India and Indians. Does it include security for our agricultural sector, multiple forms of food, resilience in the face of disasters, a stable and encouraging environment, or does it not? These questions are often depicted as “mere” social questions, but they are also economic questions because without these conditions the price of doing business is going to keep on rising, the levels of risk will climb, and we will pay for our neglect to plan for the longer-term for profits in the short-term.
Neha Kumar is the India Programme Manager for Climate Bonds Initiative and is based in Delhi. She drives policy, strategy and partner programmes in the country to scale up the green bonds market and sustainable financial ecosystem. She is currently also on the Ministry of Finance working group on Sustainable Finance Taxonomy development. Her current focus of work includes mobilising investments in resilient agriculture, diversifying green and other sustainable finance instruments to multiple sectors, and multiple issuers including the states. She has over fifteen years of experience working on public policy, regulation and industry action in India on sustainability, responsible financing and environmental and political risks to national and international investments.
Q. What is a Green Bond?
Basically, all bonds are investment tools. They are a form of debt that a company, a financial institution, municipality, or state issues, to repay at a future date - with interest - in exchange for money that it can use today to finance its expansion, for example. Green Bonds utilise the advantages of regular bonds like a fixed interest rate, long tenor, tradability, access to a much more diversified pool of investors in the debt capital markets unlike a bank loan. And they add the green as a bonus feature. Which basically means earmarking the capital you raise through a green bond for environmentally sound projects like solar power plant, clean technology investments, or climate adaptation projects.
Earmarking the use of proceeds lends a high degree of transparency. And this is what investors like.
So, for example the Indian Railway Finance Corporation raised USD 500 million to fund electrified passenger and freight rolling stock and other low carbon improvements to Indian Railways infrastructure. When you label, more importantly certify, a bond as green, there are many advantages. Firstly, you get noticed by investors who want to invest in credible green projects. That works well both for investors and issuers. So, for IRFC, it was a win, because the green bond diversified and added to their investor pool. This is a commonplace story with all green bond issuers. They get oversubscribed by 3 to 4 times and get priced tighter.
India tapped the fast-growing international green bond market in 2015 and since then has issued about USD 20 billion worth of green bonds mainly for RE
Q. Is there a growing market for green bonds in India?
Yes, definitely. The market has matured dramatically in the last few years. The first green bond was issued in 2015 in India. By 2020 the cumulative investment in green bonds had reached USD 11 billion. In 2021 alone USD 9.67 billion investment was added to this.
2021 is a mix of other thematic debt instruments too, such as green loans, sustainability linked bonds and ESG bonds etc. These have made quite a splash on the scene globally, especially in the last two years. The core idea is the same – the one pioneered by green bonds – that of earmarked use of funds for green/sustainable/social activities in a measurable way and reporting to back the claim.
Again, for perspective, this USD 20 billion is only a tiny fraction of what India could attract from global green capital pool to finance its local needs. The investment in green bonds in China, in comparison, is about 10-12 times higher than in India. Again, for perspective, combined labelled global issuance of Green, Social, and Sustainability, Transition, and Sustainability-linked bonds is over USD 765 billion in the first three quarters of 2021, and green bonds are tipped to reach a trillion a year by 2023. This universe is growing very fast even if it is a small fraction of the huge global bond market – an estimated USD 100 trillion.
India is batting much below its potential.
Our need is in trillion of dollars for mitigation and adaptation and green finance flow from both Indian and international capital sources is around 17-18 USD billion per annum according to a study by the Climate Policy Initiative.
Investments are mainly in the RE sector. While opportunities in sectors like waste, water infrastructure, agriculture exist, but haven’t yet been tapped as such.
Q. What are the problems?
I think it comes down to a lack of awareness and the ability to tap these (sustainable finance) opportunities. Plus, usual deal size for a typical green bond is above USD 300 million for it to make sense to international investors. This is difficult for small scale adaptation projects. And it comes down to definitions. What is needed to classify something as green? The renewable sector is easy, because things like solar and wind are zero emission, pure play green. Utility scale is easier than decentralised RE as it has become a well understood sector as it has matured. Other areas are less clear. Can we look at what makes green buildings green, and set clear, comparable thresholds? What counts for permissible thresholds for the transport sector? It’s globally competitive and tailpipe emission norms will be consistent with EU thresholds of 50gCO2/km soon.
Should we adopt international thresholds where they work? Well, comparability helps in cross border flow of capital.
The EU did this work from 2016 to 2021, coming up with a taxonomy or a set of definitions, a format, and thresholds. The EU had announced that it will become net zero by 2050, so they calculated backwards from that in terms of the remaining carbon space they would have and how that would be split across sectors to define if any new investment will qualify. In the end they came to a threshold of 100 grams of CO2 equivalent per KWH as the upper limit for electricity generation. India’s net zero by 2070 will be the basis for deciding the thresholds for us in India. We will need to bring down coal fired electricity drastically for the transition to be really green. Normal emission from coal in India is in the range of 700-800 gCO2/kwh.
Although EU said that their definitional system – the taxonomy – was technology agnostic, they ruled out coal altogether due to absolutely no contribution to mitigation and rather grave health and other pollution impacts. Other things, like steel or cement, are high emitters, but there is no viable technology yet for green steel, so they proposed an approach for ‘hard to abate’ sectors and said credible transition would follow best in class approach, showing significant improvement.
There are other countries, nearly 25 of them, developing their own taxonomies, including India. And now that we have also announced net zero by 2070, the question of thresholds will rest on this target year.
Actually, the declaration of net zero by developed countries by mid mid-century is a bit of a ruse, because they should be net zero now, and by declaring net zero in the future they are squeezing out the space for developing countries.
People would argue that our net zero (or any net zero) is too long into the future and what matters is what you do now. Investment is needed in this decade by 2030 for our SDG targets, RE targets etc. True. But a net zero year is useful as it helps us chart a trajectory. Let us also acknowledge at the same time that a lot of Indian companies have announced net zero by 2050. And they will go ahead anyway with more aggressive targets for reasons of competitiveness in the international market and attracting investment.
Q. What is India doing?
In August 2020 the Ministry of Finance invited a number of stakeholders, national and international, to be part of a discussion on sustainable finance. There was three-day marathon session to discuss ideas such as taxonomies, disclosures, and regulations. This led to the creation of a Sustainable Finance Task Force in early 2021, with four working groups on taxonomy, regulation, and a sustainable finance roadmap. The results should be out soon. But it is only a start.
Q. Is there an easier way to do this?
Yes, well, I feel on the green stuff there is a lot of heavy lifting done by the EU already especially on mitigation. Some countries have just copied the EU taxonomy concepts – which is not a bad approach. It keeps things comparable and the concepts make sense.
The Chinese came up with a green catalogue (which included “clean coal”) before the EU, but after the EU came out with its guidelines, China is trying to see how much of it is harmonised to that of EU They call it a common ground taxonomy and say it is 80% aligned to EU. Why did they do this? Because so much source of capital – the big investors – are European. Many other countries are doing the same.
But India has another specific challenge, and for that reason alone its attempt will necessarily need to beyond EU’s. We are a developing country in transition, and much of our population is poor. We must account for social aspects as well, things like jobs and employment, equitable access, and community empowerment. These are harder to quantify, but they are essential to any green transition by India.
Any transition that ignores social aspects is inherently fragile, and will risk damaging both the social and economic stability of the country.
Q. What are the big things in this area that we should be thinking about?
Clear common language. Both international capital and domestic investment is dependent on a common language that it can understand. This is why it is imperative to have that, and secure that. In that language we need to make sure we have what India – as a developing country – needs. Agriculture, for example, employing more than half of Indians, is already reeling under climate change impact. Therefore, adaptation and resilience become central to our efforts and financing this at scale is absolutely the key. It is a tough issue, with difficult definitions and locational aspects. And the industrial world has focused largely on mitigation. We cannot afford to do that, nor can we afford to allow the world to ignore this, thus we must take the lead. By the way, resilient agriculture also has positive knock-on effects on mitigation so it is far too important to be left for later. Similarly, biodiversity conservation.
Lastly, it is worth noting that it took a pandemic for us to acknowledge that mindless environmental degradation could result in massive outbreak of diseases, and bring economies to their knees. So, the recovery needed to be more resilient and sustainable. This was also reflected in a huge surge of thematic sustainable finance instruments during and after the pandemic. Green bonds were among the quickest to recover from an initial squeeze.
We need to enable finance. At scale. We need to unclog the channels for big- and small-sized finance reach sustainable destinations. These are challenges and opportunities that India needs to capitalise upon, and do so now.
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