India’s efforts to raise funds for green projects through sovereign green bonds are facing significant challenges due to muted investor demand. As yields on these bonds remain lower compared with regular bonds in the debt market, market participants have been avoiding them for the past two and a half years. The government has not been able to secure a meaningful green premium, making these bonds unattractive for both issuers and potential investors.
Of the two new green bonds auctioned by the Reserve Bank of India in November and January, bonds valued at Rs 7,443 crore remained unsold and were devolved to primary dealers as investors sought higher yields. The total bond issuance was worth Rs 10,000 crore. The government attempted to incentivise green bonds by changing norms to allow non-resident Indians and foreign portfolio investors to participate without restrictions. However, this move failed to attract sufficient buyers. In August 2024, the RBI accepted only Rs 1,697 crore in bids for a Rs 6,000 crore sovereign green bonds auction, and in May, it withdrew another issuance due to lack of demand.
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Since 2022-23, the government has issued green bonds eight times, raising nearly Rs 53,000 crore. Around 50% of the proceeds have been utilised to fund the production of energy-efficient three-phase electric locomotives for Indian Railways. The revised budget for 2024-25 allocates funds across several green initiatives, including Rs 12,600 crore for electric locomotive manufacturing, approximately Rs 8,000 crore for metro projects, Rs 4,607 crore for renewable energy (including the National Green Hydrogen Mission), and Rs 124 crore for afforestation under the National Mission for a Green India.
Low demand for sovereign green bonds
Sovereign Green Bonds function similarly to traditional bonds but are exclusively used to fund environment-friendly projects, such as electric locomotives and metro projects. Like several emerging markets, India turned to green bonds to finance its transition to a low-carbon economy. The framework for issuing these bonds was established in 2022, defining green projects as those that promote energy efficiency, reduce carbon emissions, enhance climate resilience, and improve natural ecosystems.
Climate change mitigation and adaptation require significant financial resources. The United Nations’ Intergovernmental Panel on Climate Change (IPCC) estimates that limiting the global temperature rise to 1.5°C, the target of the Paris Agreement, will necessitate investments of $3-6 trillion annually until 2050. Green bonds are one of the key instruments to mobilise these funds.
A major challenge for Indian green bonds is the lack of a significant green premium—the extra value investors are willing to pay for environmentally friendly bonds over conventional ones. Without a meaningful greenium, these bonds offer no financial advantage over regular bonds, making them less attractive to issuers. A higher greenium would enable issuers to raise funds at lower costs, thereby making green investments more appealing.
Currently, Indian sovereign green bonds offer a greenium of only 2-3 basis points, far below the global average of 7-8 basis points. This low premium limits their appeal as a viable financing tool. Additionally, India lacks a strong ecosystem of social impact funds and responsible investing mandates, which in other markets drive demand for green bonds.
Furthermore, small green bonds issuances and the tendency of investors to hold them until maturity have hindered secondary market trading, making these bonds illiquid. This situation effectively turns them into long-term loans rather than tradable securities.
Despite their potential, green bonds constitute only a small portion of the debt market and climate financing efforts. With weak investor interest, India is exploring alternative avenues to bridge funding gaps. These include addressing liquidity concerns, enhancing reporting transparency, and considering sustainability bonds. It is expected that these measures could help boost demand and expand green finance in the country. The government also aims to strengthen reporting practices and introduce incentives to attract investors.
Lessons from global markets
To boost investor confidence and increase the adoption of sovereign green bonds, the Indian government and financial institutions should consider issuing more sustainability bonds, which combine green and social project financing. A recent World Bank report indicates that emerging markets have attracted greater investor interest in these combined-purpose bonds compared to solely green bonds, which are more common in advanced economies. Broadening the scope of green bonds to include social benefits alongside environmental ones may help India attract a wider pool of investors looking for both financial returns and positive social impact.
Beyond the type of bond issued, improving transparency and timeliness in reporting is also crucial. The World Bank highlights the importance of post-issuance allocation and impact reports for investors. These reports provide crucial insights into the use of proceeds and the effectiveness of funded projects. India’s Department of Economic Affairs should prioritise publishing timely and comprehensive allocation reports, including the outstanding report for 2023-24.
Partnering with multilateral development banks to leverage their higher credit ratings could significantly enhance investor confidence in Indian green bonds. Such collaborations could reduce perceived risk, making these bonds more attractive and leading to greater participation in future issuances. Multilateral institutions such as the International Finance Corporation (IFC) and the World Bank have previously guaranteed green bonds in developing countries, increasing investor confidence and driving demand.
Role of global investors
The United States is one of the largest sources of green bonds, with issuances led by the government-backed mortgage giant Fannie Mae. Corporations such as Apple, PepsiCo, and Verizon have also entered the green bond market, while state and local governments use these bonds to finance infrastructure projects.
A key challenge that the Indian government must address is the risk of greenwashing, where bonds make misleading claims about their environmental benefits. Investors are increasingly wary of such issues, which have plagued the broader sustainable investment market. Strengthening regulatory oversight and ensuring robust verification mechanisms are crucial to maintaining investor trust.
As the global green bond market continues to expand, India must not let this opportunity slip away. Green bonds remain a crucial component of the push toward sustainability. However, India must take strategic steps to enhance their attractiveness, including improving transparency, expanding the scope of green bonds, and ensuring a meaningful greenium. Whether India can effectively leverage green bonds to meet its ambitious climate goals remains to be seen.