The Intergovernmental Panel on Climate Change issued an urgent call to action in 2022. To meet the target of limiting global warming to 1.5 degrees Celsius above pre-industrial levels, global greenhouse gas emissions must be reduced by at least 43 per cent by 2030 compared to 2019 levels. For this, an annual global reduction of 9 per cent is necessary till 2030. But presently, an annual reduction of just 2 per cent is being achieved.
India has committed itself to achieving the 1.5-degree target, binding its states to contribute. However, can this goal be met without the requisite financing? India’s total climate financing requirements are estimated to be around 5 to 6 per cent of the annual GDP by 2070. Further, an annual investment of about 2.5 per cent of GDP is required to bridge the infrastructure gap by 2030.
During its G20 presidency in 2023, India contributed the NK Singh-Larry Summers report on multilateral development bank (MDB) reforms. This report examines the financing needs of emerging market and developing economies (EMDEs) and the role MDBs can play in bridging the gap. The first part of the two-volume report recommends a $3 trillion increase in MDBs’ annual spending by 2030, with $1.8 trillion allocated for additional climate action and $1.2 trillion for achieving other Sustainable Development Goals (SDGs).
This is a grand vision. However, it is only one part of the equation.
Also Read: Lifting the smog won’t be cheap. India must think finance for cleaner air
The green finance challenge
Almost all assistance provided by MDBs is through concessional loans, and the problem of green finance will not be addressed adequately through increased debt flows. With global government debt on the rise, most countries face fiscal stability issues and do not have the borrowing capacity to meet the gigantic resource demand.
Persistent inflationary pressures are turning central banks away from sustaining growth post-Covid and towards more vigorous inflation targeting. And as the IMF’s Global Financial Stability Report 2023 notes, “low-income countries should strengthen efforts to contain risks associated with their high debt vulnerabilities”. The Government of India’s budgeted fiscal deficit was 5.9 per cent of the GDP in 2023-24. As of March 2023, its liabilities were 57.1 per cent of the GDP, reflecting a 174 per cent rise since 2013-14, while the combined debt of state governments was about 28 per per cent of GDP.
Although there is a renewed interest in private capital, it cannot significantly finance the green transition. MDBs are already co-lending to projects with private finance. However, from 2016 to 2021, only $120.8 billion was mobilised from the private sector by multilateral and bilateral financial institutions. Institutional finance is shy of excessive corporate exposure, with central banks setting more stringent prudential norms. Capital markets, too, demand sterling credit ratings.
Therefore, there is an urgent need to develop financial instruments that blur the line between public and private finance and create a circularity between them. If financial instruments can be created to enable circular flow between public and private finance, governments can borrow and build green infrastructure and “downsell” these to private partners. This way, the government can unlock capital, allowing it to repay earlier loans, contract new ones, and invest in new infrastructure assets. This circularity will continuously make headroom for sovereign borrowing without creating fiscal instability.
A case for Infrastructure Investment Trusts
Infrastructure Investment Trusts (InvITs), a unique financial instrument developed in India, could create a smooth channel for significant amounts of capital toward green infrastructure in the states.
Straddling the capital markets and institutional finance regulatory universe, InvITs are designed to unlock investor appetite through the capital markets in the form of debt and equity. With an attractive tax structure and robust risk matrix, InvITs can create circularity between public and private finance, as well as debt and equity, making them a viable tool for bridging the green resource gap.
Functioning similarly to mutual funds, InvITs pool money from investors and invest it in income-generating infrastructure assets.This allows financial institutions, corporations, and high net-worth individuals (HNIs) to invest and exit quickly with market-determined valuations. InvITs can raise up to 70 per cent of their resources through bond issuance. By offering a mix of completed and incomplete projects, InvITs provide a bouquet of options with diversified risks to investors.
MDBs and bilateral financial institutions typically lend to governments, which may also secure funding from sovereign wealth funds or through capital markets. Once the construction risk is over and the projects have reached the exit stage, the sponsor governments can settle InvITs and monetise future earnings by issuing units. They can repay debts and contract new ones without any overhang on fiscal deficit ceilings. Private finance effectively replaces public finance through InvITs. This virtuous cycle would assist governments in scaling up the creation of green assets and facilitate a smooth and timely transition to sustainability.
Also Read: Mitigation alone won’t do. Joshimath showed India must prioritise climate adaptation too
A paradigm shift
The adoption of InvITs requires a paradigm shift in how public infrastructure projects are designed and structured financially. To achieve this, a a common framework with several key elements needs to be established.
(a) Taxonomy: Finance taxonomies play an essential role in facilitating the flow of finance. To increase green finance, there must be a nationally accepted framework defining terms and concepts. This will improve market clarity and enable the creation of specific incentive and disincentive structures, including tax treatment.
(b) Harmonisation of regulations: Traditional public procurement involves the documentation of service-level standards, standard costing, and model contracts. Identifying, quantifying, and costing “green material” and codifying it in a “green building standard rates code” is a critical need.
(c) Standardisation of risk evaluation: Investments in InvITs require a distinct set of standards to assess risks and provide ratings. Credit rating agencies must fully factor in the unique features of InvITs and their risk mitigation framework. Lending to the infrastructure sector is complex, and risk assessment cannot be done through existing methodologies.
(d) Capacity building: There is an urgent need to build capacities in the states to tackle systemic risks. The capacity to produce bankable detailed project reports (DPRs) based on life cycle costs is currently nascent. It’s important to create a class of public officials who can deal with these issues effectively.
(e) Strengthening institutions to support state efforts: To prepare bid-ready bankable projects, states must create fit-for-purpose institutions. For instance, Rajasthan has created PDCOR Ltd, which helps state departments with legal documentation and transaction advisory services. Such institutions should be repurposed to assist the state governments in preparing projects for future monetisation through InvITs.
The Indian financial markets are now seeing the power of InvITS. The Finance Ministry, which developed the concept of InvITs in 2012-13, could take the lead in developing the country’s green infrastructure framework.
The author is a former finance secretary to the Government of India and currently chairman of the Institute of Development Studies, Jaipur. Views are personal.
(Edited by Asavari Singh)