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Why has India allowed FIIs to Invest in its Sovereign Green Bonds (SGrBs)?

Context: The Reserve Bank of India (RBI) has approved  Foreign Institutional Investors (FIIS) to invest in the Sovereign Green Bonds (SGrBs).

  • India’s commitment to achieving net-zero emissions by 2070, as announced by Prime Minister Narendra Modi at COP26, necessitates significant investment in green projects.
  • Sovereign Green Bonds (SGrBs) have emerged as a crucial instrument in funding initiatives aimed at accelerating India’s transition to a low carbon economy.

What is Sovereign Green Bonds?

  • Sovereign Green Bonds are financial securities with fixed interest rates, issued by national governments, inter-governmental organisations, or corporations.
  • The funds raised from these bonds are dedicated exclusively to projects aimed at environmental sustainability and climate resilience.
  • In the 2022-23 Union Budget, the Indian government announced its plan to issue Sovereign Green Bonds (SGrBs) as part of its borrowing strategy to finance green infrastructure projects.
  • The operational guidelines for these bonds were established by the government in November 2022.

Purpose of Sovereign Green Bonds

  • Green bonds are bonds issued by a sovereign entity, inter-governmental groups alliances and corporations with the aim that the proceeds of the bonds are utilised for projects classified as environmentally sustainable.
  • These Green Bonds have emerged as an important financial instrument to deal with the threats of climate change, as they connect environmental projects with capital markets and investors and channel capital towards sustainable development.
  • Purpose: SGrBs are government debt instruments specifically designed to finance projects that contribute to India’s transition to a low-carbon economy.
  • Net-Zero Goals: SGrBs play a vital role in funding initiatives aligned with India’s ambitious net-zero emissions goals, including sourcing 50% of energy from non-fossil fuel sources and reducing carbon intensity by 45%.
  • Oversubscribed Tranches: In January and February last year, the Reserve Bank of India (RBI) issued SGrBs worth ₹16,000 crore in two tranches. Despite being oversubscribed, the participation primarily comprised domestic financial institutions and banks.

Framework for Issuance of SGrBs in India

  • The framework draws from the International Capital Market Association’s (ICMA) Green Bond Principles, which provide principles of voluntary best practice guidance on the use of proceeds, the process for project evaluation and selection, management of proceeds and reporting.
  • The Ministry of Finance has constituted a Green Finance Working Committee (GFWC) to facilitate the process of project evaluation and selection.
  • The funds raised through the issuance of green bonds will be deposited in the Consolidated Fund of India (CFI).
  • Further, the Public Debt Management Cell (PDMC) will keep track of proceeds and monitor the allocation of funds towards eligible green expenditures.

Advantages of Sovereign Green Bonds

  • Security: Being government-issued, these bonds offer minimal risk of credit default, making them a secure investment option.
  • Sustainable Investment: They provide an opportunity for investors interested in contributing to sustainable and environmentally friendly initiatives.
  • Risk-Free Projects: Investors in Sovereign Green Bonds are insulated from risks associated with the financed projects since repayments of principal and interest are guaranteed regardless of project outcomes.

Risks Involved with Sovereign Green Bonds

  • Potential for Greenwashing: There’s a concern that the environmental benefits promised by projects funded through these bonds might be overstated or misrepresented.
  • Credit Rating Sensitivity: For governments seeking international investors, the attractiveness of these bonds is heavily influenced by the country’s credit rating, which reflects the overall risk of investing in such bonds.

Role of Foreign Institutional Investors (FIIs)

  • Widening Capital Pool: Allowing FIIs to invest in India’s green projects expands the capital available for funding the country’s sustainability goals.
  • Interest in Diversification: FIIs are seeking to diversify their green investments, attracted by regulatory support and opportunities in emerging markets like India.
  • Addressing Greenwashing Concerns: India’s Sovereign Green Bonds Framework, introduced in 2022, addresses greenwashing fears and provides FIIs with credible investment opportunities.

Challenges and Opportunities

  • Greenium: SGrBs yield lower interest rates compared to conventional G-Secs, leading to a “greenium” for investors. Governments worldwide are encouraging financial institutions to embrace greeniums to support green initiatives.
  • Green Taxonomy Gap: The absence of a green taxonomy poses challenges in assessing the environmental credentials of investments, risking greenwashing. India’s SGrB Framework seeks to bridge this gap by defining eligible projects and ensuring governance standards.
  • Optimizing Proceeds: To maximize the impact of SGrB proceeds, there is a need to identify new green projects with credible audit trails and high impact, especially in sectors with limited private capital.

Foreign Institutional Investor (FII)

FII (Foreign Institutional Investor) A person or company that invests in a country other than the one where it is registered or has its headquarters. In India, this term is commonly used to describe foreign entities that invest in the country’s financial markets. FIIs include institutions such as mutual funds, insurance companies, and pension funds.
Registration FIIs are registered with the Securities and Exchange Board of India (SEBI).
Investment Type Portfolio investment in the stock market by buying shares and debentures in another country.
Objective Typically short-term investments to make quick profits. Also known as “hot money” or “fly-by-night money.”

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Who is conducting the first-ever Sovereign Green Bond (SGrBs) auction?

The Reserve Bank of India is conducting the first-ever Sovereign Green Bond (SGrBs) auction.

Who can invest in SGBs in India?

Indian citizens and institutions, including NRIs (Non-Resident Indians) under the Fully Accessible Route (FAR), can invest in SGBs.

Are there any risks associated with SGBs?

Like any bond, SGBs carry interest rate risk, meaning the market value can fluctuate if interest rates rise. There's also the risk of the government defaulting on the bond, though this is generally considered very low for sovereign bonds.

How are SGBs issued in India?

The Indian Ministry of Finance, in collaboration with the Green Finance Working Committee (GFWC), oversees the issuance of SGBs. The Reserve Bank of India (RBI) facilitates the actual issuance and manages the subscription process.

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