Unlocking sustainable investments: The Reserve Bank of India's crucial role in energy transition

India's net-zero targets by 2070 require a massive investment of approximately US$10 trillion. Mobilising such ambitious investments will require a collaborative effort from all entities in the financial system. The Reserve Bank of India (RBI) is one of the key players whose role is increasingly significant in mitigating the risks involved in the transition to a low-carbon economy.

RBI’s recently released report on currency and finance underlines this fact. The report proposes several measures the central bank can employ to attract investments towards expediting India's energy transition, enabling the country to achieve its net-zero objective by 2070.

RBI’s Report Leverages on Global Experiences in Growing Green Finance  

Over the past few years, central banks and financial regulators worldwide have recognised the importance of addressing climate change risks that can significantly impact the financial system's stability and the broader economy. As a result, several central banks have established frameworks at both micro and macro levels, incorporating climate risks into their prudential approaches and utilising innovative monetary policy mechanisms to encourage investments in climate-friendly assets.

Drawing cues from various central banks worldwide, the RBI’s report suggested several monetary policy and prudential regulations that it can use to mitigate climate risk while creating a conducive environment for investments to flow into climate-friendly assets. The proposal includes a new scheme to lower borrowing costs for renewable energy firms by extending priority sector lending and providing low-cost funds to banks. They also consider accepting Sovereign Green Bonds as collateral, offering more flexibility in margin requirements. Additionally, the central bank proposes to adjust reserve requirements to support credit flows to green sectors.

These initiatives are commendable and put the RBI among the few central banks globally that are actively pursuing efforts to tackle climate risks. Though, there are several other levers under the ambit of RBI for countering climate risks that will also unlock domestic and international capital into low-carbon assets in India.

Additional Options Available with RBI to Unlock Domestic Capital for Energy Transition

On the monetary policy front, the RBI can alter the Collateral Framework for Statutory Liquidity Ratio (SLR) for commercial banks in the country. The central bank uses the SLR as one of the primary tools for reserve requirements for maintaining price stability in the economy. Changes in collateral requirements for SLR can lead to support for investments dedicated to low-carbon assets. Currently, only state and central government debt qualify as SLR eligible, excluding corporate bonds. With sustainable debt issuance in India reaching US$8.5 billion in the financial year (FY) 2022, of which corporations raised a significant portion, designating sustainable bonds from top-rated issuers as eligible for SLR would give a strong impetus to the domestic sustainable finance market. This approach aligns with global practices where central banks like the US Federal Reserve, the European Central Bank, and the Bank of England hold corporate debt exposure on their books.

On the prudential regulation front, the RBI can establish the Countercyclical-Climate Buffers. Basel III norms introduced capital buffers for banks, namely the capital conservation buffer and countercyclical capital buffer (CCyB). While the RBI has implemented the capital conservation buffer, the CCyB is pending. Climate risk requires a dedicated capital buffer as it poses systemic risks. Current buffers do not fully address climate-related risks. A climate risk buffer linked to loan composition would promote lending to low-carbon assets.

Additional Options Available with RBI to Unlock Foreign Capital for Energy Transition

The RBI can ease the External Commercial Borrowing (ECB) norms to draw foreign investment in India’s clean energy sector. It can achieve this by recognising the clean energy sector as a separate industry and relaxing sectoral caps, allowing borrowers to raise funds beyond the current limit of US$750 million per year. Furthermore, the RBI can boost the attractiveness and financial feasibility of foreign investment in clean energy projects by taking certain steps to reduce the cost of currency risk hedging. One approach could be to create a dedicated hedging pool for clean energy companies borrowing through ECBs. 

The RBI can explore innovative approaches to leverage its forex reserves as an investment catalyst. For example, central banks like Sweden's Riksbank and Banque de France have incorporated climate risk considerations into their foreign exchange reserves. Hungary's Central Bank has even created a specialised green bond portfolio within its reserves. India holds over US$580 billion in forex reserves, making it a prime opportunity to mobilise foreign investment in clean energy infrastructure. By strategically allocating a small portion of reserves under the management of the RBI towards risk mitigation initiatives like currency hedging subsidies and credit guarantees, India can attract substantial foreign investment, potentially amounting to billions of dollars.

The role of RBI is pivotal in driving sustainable investments and managing risks in India's transition to a low-carbon economy. By adopting innovative measures and leveraging global experiences, the RBI can attract capital into climate-friendly assets, supporting India's net-zero goals. Moreover, the RBI's commitment to addressing climate risks and promoting sustainability would be instrumental in shaping a climate-resilient financial landscape.

An abridged version of this article was first published by The Hindu Business Line.