The government released the framework for sovereign green bonds in November last year. The central bank followed in the New Year by announcing an issuance calendar for these bonds on January 6. This explainer goes behind the green bonds framework and the issuance calendar.
What are sovereign green bonds?
A green bond is a debt security that is issued to raise capital to support climate-related or environmental projects, according to the World Bank. Sovereign green bonds are issued by governments to raise resources for such projects.
In the Union Budget for FY23, finance minister Nirmala Sitharaman announced that the government will issue green bonds.
‘As a part of the government’s overall market borrowings in 2022-23, sovereign Green Bonds will be issued for mobilising resources for green infrastructure. The proceeds will be deployed in public sector projects which help in reducing the carbon intensity of the economy.’
What does the framework entail?
The government’s framework is based on the International Capital Market Association’s listed principles for issuing green bonds, which has four components: Use of proceeds, project evaluation and selection, management of proceeds, and reporting.
The government said the bonds’ proceeds will be used for green projects that:
· Encourage energy efficiency
· Reduce carbon emissions and greenhouse gases
· Promote climate resilience and/or adaptation
· Improve natural ecosystems and biodiversity, especially in accordance with the principles of sustainable development goals
The framework listed investments in solar, wind, biomass, and hydro energy projects, and urban mass transportation projects such as metro rail, green buildings, pollution prevention and control projects. The government excluded projects such as fossil fuels, nuclear power generation, and direct waste incineration.
The eligible expenditure is limited to government spending that occurred not more than 12 months prior to issuance. The proceeds should be allocated to projects within 24 months of issuing the bonds. If an eligible green project is postponed or cancelled, it will be replaced by another eligible green project.
How will green projects be evaluated and reported?
The Ministry of Finance has constituted a Green Finance Working Committee composed of relevant ministries and chaired by the chief economic adviser. The ministries will submit their projects to the committee, which will meet at least twice a year to evaluate the proposals.
Once the projects are evaluated, the final list will be given to the budget division of the finance ministry. The division will then issue the bonds through the Reserve Bank of India and use proceeds to finance the selected projects.
The government will release an annual report on the selection of green projects, the funds deployed, and their impact on the greening of the economy. It will also maintain a Green Register with details of the green bond issuance, the proceeds generated, allocations made, and information about the eligible projects.
Apart from green bonds, the government will finance green projects from its tax receipts as well.
How will green bonds be issued?
The government will inform the RBI about the amount of eligible green expenditure and the funding required from green bonds. For FY23, the government had earmarked Rs 16,000 crore for green bonds.
The RBI issues a half-yearly calendar of government borrowings from bonds. The central bank issued the calendar in January because the government released the framework in November 2022. From next year, the green bonds will be included in the general calendar.
The RBI calendar shows the government plans to issue bonds in two tranches of Rs 8,000 crore each in auctions on January 25 and February 9. The bonds will be issued in maturities of five years and 10 years and can be traded like other government bonds.
What are the unclear aspects of green bonds?
The first issue is to maintain liquidity and enable trading in these bonds. The RBI said green bonds will be eligible for statutory liquidity ratio and repo transactions. These measures will help to maintain liquidity and enable trading of these bonds.
Another way to ensure liquidity is to issue twin bonds, as in the case of Denmark. Under this system, two similar and interchangeable bonds are issued, allowing investors to switch from one to the other and leading to more liquidity and trading. The government and the RBI issued market stabilisation bonds based on the twin bond approach earlier.
The second matter is the interest rate on these bonds. Will investors buy green bonds at a higher or lower price than general bonds of similar maturity? The markets have termed the difference in prices between green bonds and general bonds as ‘greenium.’
Green bonds were first issued in 2016 and early research showed that they generate a small premium for the issuers. Research by US Federal Reserve economists shows that corporate green bonds have a yield spread that is 8 basis points lower relative to conventional bonds.
Will green bonds lead to a greenium for the government? Investors will first need more information about the green projects. In the beginning, there could actually be a ‘greendiscount’ as investors will be uncertain about aspects such as liquidity and tradability.
The third aspect is to ensure that green bonds remain part of the overall borrowing programme and part of the budget. The government has often used such thematic bonds off the balance sheet, which leads to an underestimation of the overall borrowings and deficits.