Green bonds are a type of debt instrument issued to raise funds exclusively for environmental and climate-related projects. They provide investors a dual benefit: financial returns and the opportunity to support sustainable development. In India, green bonds have been targeted to fund nine critical areas which are, renewable energy, energy efficiency, clean transportation, climate change adaptation, biodiversity conservation, pollution prevention, green buildings, sustainable land use, and water and waste management systems.
In November 2024, The Reserve Bank of India (RBI) aimed to raise ₹5,000 crore in its latest green bond auction but could only raise ₹1,502 crore, at a yield of 6.79% interest. The remaining amount of ₹3,498 crore devolved to primary dealers (financial institutions).
This limited interest reflects weak demand and underscores several systemic challenges in India’s green bond market. One of the primary reasons stated are that there was no mandate for the investors to invest at a low yield, the unwillingness of the investors to pay the “greenium” (the difference in the yield between green bonds and other bonds). Unlike global markets where green bonds often trade at a slight premium due to their environmental credentials, the Indian market had a yield of 6.79%. Additionally, liquidity concerns in the secondary market and the absence of mandatory investment mandates further deterred investors.
Earlier this year in May, the RBI cancelled the 10 year green bonds auction due to insufficient bids.
The main challenges faced in the Indian Sovereign green bonds market are the investors’ reluctance to accept lower yields, as green bonds often offer no distinct financial advantage over traditional debt instruments. Limited awareness about the environmental and financial benefits of green bonds further dampens demand, particularly in emerging markets like India. Transparency issues also persist, as weak implementation and inadequate reporting mechanisms, despite SEBI’s established frameworks, undermine investor confidence. Additionally, the lack of liquidity in secondary markets makes green bonds less appealing to investors seeking flexibility. Lastly, the current market structure and design of green bonds, which predominantly target banks, fail to attract long-term institutional investors like insurance companies and pension funds, who prefer bonds with longer maturities. These factors collectively hinder the growth and acceptance of green bonds in India.
To improve the acceptance and effectiveness of green bonds in India, a multi-faceted approach is necessary. Firstly, building a sustainability-oriented business culture is essential. Drawing inspiration from Scandinavian countries like Sweden, India must integrate sustainability into corporate practices. Mandates requiring companies to prioritise green investments can help align business objectives with environmental goals. The Business Responsibility and Sustainability Reporting (BRSR) guidelines introduced by SEBI in 2021 are a positive step, encouraging businesses to transparently disclose their sustainability performance and fostering a culture of accountability.
Secondly, enhancing transparency and reporting mechanisms is critical for boosting investor confidence. India can borrow from Brazil’s successful model by developing a green bond taxonomy to clearly define eligible projects, allocation processes, and verification standards. Such a framework would ensure that funds are utilised effectively and transparently, thereby fostering trust among investors. Improved implementation and robust reporting systems can further strengthen this effort.
Focusing on municipal-level green bonds offers another avenue for growth. These bonds have the potential to fund localised climate adaptation and mitigation projects effectively. However, it is vital to build capacity at the municipal level by training officials, developing region-specific frameworks, and ensuring strong managerial capabilities. These steps would enable municipalities to access green financing and diversify the bond market.
Incentivising investments is another crucial strategy. The government could introduce measures such as tax benefits or guarantees to make green bonds more attractive. Additionally, establishing investment mandates for institutional investors, including insurance companies and pension funds, could help mobilise capital for sustainable projects. Such incentives would create a more favourable investment climate for green bonds.
Lastly, diversifying bond structures is necessary to attract a broader range of investors. Issuing longer-tenure green bonds tailored to long-term investors, such as insurance companies, could significantly expand the investor base. For example, 30-year bonds are likely to appeal more to these investors than the current 5-10 year offerings.
Hence, green bonds represent a vital instrument in India’s transition to a low-carbon economy, funding projects that mitigate climate change and conserve biodiversity. However, the recent failure of the RBI’s green bond auction highlights systemic challenges, from limited awareness and transparency to insufficient market incentives. Addressing these issues through structural reforms, enhanced transparency, and targeted incentives can unlock the full potential of green bonds.
