A 'greenium' matters for India's first sovereign green bond issue

Sovereign green bonds (SGBs) are gaining traction in the sustainable finance markets.

India’s sovereign green bond issuance plans seem to be solidifying, with the finance ministry recently announcing the government’s second-half borrowing plan. The green bond issue size is Rs160 billion (US$2 billion) or close to 1% of the overall borrowing for the fiscal year (FY) 2022-23.

Sovereign green bonds (SGBs) are gaining traction in the sustainable finance markets. Since Poland's first such issuance in 2016, the market has grown fast, with 11 issuers raising a total of US$78 billion in 2021 alone.

SGBs offer huge benefits to meeting sustainable goals

These instruments offer benefits for issuers and investors. Besides helping finance a country’s individual pledges as part of the Paris Agreement, SGBs send market signals to indicate the nation’s energy transition commitment.

Sovereign green issues have helped grow private green bond markets.

Other benefits are better premiums, longer maturities and access to a new segment of investors. For investors, a sovereign guarantee provides cushioning against credit risk or risk of default by the issuer and transparency compared to similar private issuances. Additionally, as seen in other markets, sovereign green issues have helped grow private green bond markets.

For the Indian government, a successful green bond issue would entail achieving a pricing premium of 15-25 basis points over plain vanilla government bonds.

Tepid global scenario raises risks with SGBs issuance

Considering the current global scenario, rapid interest rate hikes by the US Fed and increasing US treasury yields, capital has fled from emerging market bonds. Further, new issuances in offshore markets have also shrunk due to concerns regarding dollar strengthening.

The SGBs would, in all probability, be rupee denominated and issued in onshore markets. Hence it will be challenging for the issue to get a favourable premium. This is because most environmental, social and governance (ESG) aligned investors ready to pay a premium for sustainable bond instruments are from developed markets. Indian investors are yet to differentiate pricing between a green bond and the normal rupee bond.

Several favourable conditions remain in the Indian market

After the government’s second-half borrowing calendar announcement, overall borrowing has reduced by Rs100 billion (US$1.2 billion) with no indication of any additional borrowing. This sends a positive market signal on the government’s fiscal position. Further, despite an adverse global scenario, the postponement of India’s global bond index inclusion and continuous monetary policy committee (MPC) rate hikes, the 10-year sovereign government bond continues to trade within a range.

In addition, foreign portfolio investments in Indian debt markets have risen since August 2022 and hit a seven-month high in September, showcasing the improving sentiment of foreign investors.

Greenium is a huge incentive to issue SGBs

Empirical evidence of “greenium” in sovereign bond issuances suggests that it is larger for emerging market economies. The greenium estimates for emerging markets are 49 and 12 basis points for dollar and euro-denominated bonds, respectively, compared to 5 to 6 basis points for advanced economies. Though rising green bond supply in the market lately could have led to falling greeniums on such issues. Further, Asian emerging market economies have not seen such greeniums to date.   

Focus on greenium drivers is the way forward

For a greenium, the Indian government must take all possible measures. It is already developing a green bond framework in line with global standards, which is essential to ensure legitimacy with investors. A crucial aspect will be establishing a pipeline of eligible “shovel-ready” projects following the bond framework, which third-party consultants, environmental experts and multilateral organisations further assess.

Eligible projects should also align with the definitions and criteria established under global green taxonomies, such as the European Union’s taxonomy. Investors in these jurisdictions want to invest in taxonomy-aligned projects due to regulatory reporting requirements and avoiding greenwashing risks. Additionally, the framework should establish that the total outstanding amount of green bonds will not exceed the amount of eligible green expenditures.

Pioneered by Germany, another global innovation in sovereign green issuances is the concept of twin bonds. Here the green bond will have the same financial characteristics as the central government's existing conventional on-the-run issues. This supports liquidity for green bonds, as investors can make a one-to-one switch at any time between the green bond and the more liquid conventional twin bond. It also provides visibility on the greenium. Indian authorities may also consider twin issuances to improve liquidity and hence greenium.

On the domestic end, regulatory pressure on institutional investors, such as the Life insurance Corporation of India (LIC) and Employee Provident Fund Organization (EPFO), through their sectoral regulators to incorporate ESG or climate risk considerations into their portfolios will help raise the bond’s demand.

Higher demand from local investors will provide confidence to foreign investors and lead to lower yields for the issue.

Domestic banks should also be encouraged to participate in the issue to diversify their portfolio. The Reserve Bank of India’s discussion paper on climate risks faced by its regulated entities should be a nudge for domestic banks. Higher demand from local investors will provide confidence to foreign investors and lead to lower yields for the issue.

This article was first published by Financial Express