India flag flying

After debuting in the sovereign green bond market with two $1 billion local currency deals in January and February, India has announced plans to raise another $2.2 billion equivalent in the format in the second half of the year.

Policymakers have indicated that the next tranche of sovereign green bonds will introduce a 30-year tenure, versus five and 10 years in the first issue.

The bond sales are part of a broader push by India to develop a domestic ESG and green bond market. Last year, it launched green bond framework, which includes classification of green activities, close monitoring of fund utilisation, and enhanced reporting standards for funds raised through these bonds.

India aims to become a net zero economy by 2070. According to the International Finance Corporation (IFC), the country will require climate financing worth $3.1 trillion from 2018 to 2030 to meet this objective. But there are still question marks over whether green bonds will become a key instrument to raise the requisite climate financing.

Liquidity issues

The first tranche of the sovereign green bond has become almost illiquid due to lack of trading activity.

“We are somewhat disappointed by the lack of commitment by the government to this programme, as the sporadic issuance of green bonds has led to a relative lack of liquidity in these bonds,” analysts at Nomura said in a report dated 27 September.

Not only has the first sovereign green bond lost its greenium, it has been trading at a discount to conventional bonds. At the time of issuance on 25 January, the green bond priced to yield 7.29 percent, six basis points inside the conventional sovereign yield curve.

In August, the average yield of 10-year sovereign green bonds was 7.20 percent, versus 7.17 percent for the equivalent vanilla bond.

“Small issuances are getting absorbed quickly by long-term investors, making the trading opportunities limited due to lack of adequate supply,” said Venkatakrishnan Srinivasan, founder of Rockfort Fincap, a financial advisory firm.

Ajay Manglunia, head of the investment grade group at JM Financial, believes that liquidity in sovereign green bonds will improve once the government starts issuing multiple tranches. “At present, investors are holding onto these bonds because, if they sell, they will have to suffer mark-to-market loss,” he said.

Eyeing long-term investors

By increasing the tenure of sovereign green bonds, the government is hoping for more participation from pension funds and insurance companies looking for long-term instruments.

Indian insurance companies are required to invest at least 15 percent of their investment in infrastructure funds. In January, the government classified investments in green bonds as infrastructure investments.

“Insurance companies, [and] large provident and pension funds may get attracted with long tenor sovereign green bonds,” said Srinivasan. “Further, the government has already classified investments in sovereign green bonds as investments in infrastructure, which specifically attract insurance companies to invest in green bonds.”

The first tranche of green bonds was mostly subscribed by banks, according to market participants. Indian banks are required to invest a certain amount of funds in government securities to maintain their statutory liquidity ratio (SLR).

“In India to date, we don’t have any specific dedicated green or ESG fund and hence green or ESG bonds are yet to witness any broader acceptance from onshore investors,” added Srinivasan.

“Further, with the ongoing compressed yield spread between US treasury and Indian government bonds, we don’t expect any major inflow from foreign portfolio investors. Hence, the Indian government will have to attract onshore investors only.”

The market considered the first green bond issuance as a normal government bond, as they did not see special incentive to invest in them over normal bonds, said Manglunia.

Last week, JPMorgan said it would add Indian government bonds to its emerging market debt index – a move that might attract foreign investors in the Indian green bond space. This is the first time Indian bonds have been included in a globally traded bond index.

“India does not have any ESG funds that specifically invest in green bonds. Insurance or pension funds do not get any special rate to invest in them,” said Manglunia. “However, going forward, we expect more interest in investors, especially among FPIs, after India will be included in the JPMorgan index.”

Missing corporate bond market

The size of the domestic bond market in India currently stands at around $2 trillion, of which more than 90 percent comprises government securities.

In the corporate market too, only a handful of companies choose to raise domestic green bonds. Most larger Indian companies prefer to raise green bonds abroad.

Indian firms had raised $16.5 billion in green bond financing as of March 2023. Most of these bonds were raised by a handful of big industrial companies such as Adani, Greenko and REC, as well as the country’s largest public sector lender, State of Bank of India.

The cost of funding from green bonds is hardly lower than traditional bonds when it comes to long-term financing needs, notes Harsh Shah, CEO of power sector infrastructure investment trust IndiGrid.

Vishal Pandya, co-founder of REConnect Energy, a climate tech start-up, says Indian mutual funds could help to kick start the market.

“The industry is large and if the retail said something could accelerate their funding in the green bond market, we could see some traction,” he said. “The Indian green bond market has not been attractive for investors, especially mutual funds, as there is no specific tax benefit for investors as well as issuers of green bonds.”

According to data from financial markets regulator the Securities and Exchange Board of India (SEBI), 15 Indian firms have raised some $550 million in the domestic green bond market since 2017.

“By having a top-level framework policy, the government has sent a strong signal to the investors that it is serious about developing the domestic green bond market,” says Jingwei Jia, an ESG research analyst at Sustainable Fitch. “However, India has a long way to go to develop the green bond market.”

While India has come out with a framework for green bonds, in the absence of a sustainable finance taxonomy, international investors are not confident about investing in green bonds, especially those of smaller companies, Jia added.