India stands at a crossroads of change, with an ambitious vision to transition towards a sustainable and low-carbon energy future. By 2070, the country is projected to see its population surge of a quarter billion people, along with substantial gross domestic product (GDP) growth, soaring from USD 3 trillion (2023) to around USD 27 trillion (2070). Despite having current per capita energy consumption of just one-third of the global average, the country’s energy demand is likely to increase significantly with its economic expansion.
Recognizing the importance of combatting climate change, India has set a target of reaching net zero by 2070. On the way towards this goal, ambitious targets for 2030 include:
• Meeting 50% of energy requirements from renewable energy
• Reaching non-fossil-fuel capacity of 500 GW
• Reducing carbon emissions by 1 billion tonnes
• Reducing carbon intensity by 45%, from 2005 levels
Climate finance needs
India’s envisioned monumental energy shift will be expensive. It will involve scaling up renewable energy installations, modernizing infrastructure, and improving energy efficiency across sectors. To meet its ambitious renewable energy targets, India requires formidable capital investment in solar, wind, hydro, and other clean energy-supporting technologies. India’s original Nationally Determined Contribution estimated that the country’s climate action would require USD 2.5 trillion from 2015-2030, roughly USD 170 billion per year. India will need cumulative investments of USD 10.1 trillion to significantly scale up its climate transition and achieve net-zero emissions by 2070. This prompts the need for innovative financial solutions. India’s sector-specific financial institutions (FIs) will be pivotal in facilitating the necessary flows of green finance to enable the low-carbon transition.
Despite the challenges, India has made commendable progress in attracting green finance. As per CPI estimates in 2019-20, a total of USD 44 billion was raised, marking an increase of 150% on 2017-18 . These strides are laudable but inadequate. Current investment represents approximately 25% of the total required across sectors just to meet the country’s NDCs . While climate related foreign direct investment (FDI) has increased substantially, to reach USD 1.2 billion in FY2020, this only accounts for ~3% of total FDI during that year.
To bridge the climate finance gap, India needs to exploit the rapidly growing pool of global green capital from sovereign wealth funds, global pensions, private equity, and infrastructure funds. Ways to do so include addressing barriers to investment in transition projects, fostering a sustainable finance ecosystem, and diversifying funding sources.
Mobilizing substantial capital from traditional sources presents multifaceted challenges. One key obstacle is the perceived risks associated with low-carbon projects, particularly in emerging economies. Investors may view such projects as uncharted territory, characterized by uncertainties that could limit returns, creating a reluctance to commit large sums of capital.
Additionally, the capital-intensive nature of such projects, coupled with lengthy gestation periods and evolving regulatory frameworks, can create misalignment between investor expectations and project timelines. According to CPI analysis, flows of global capital to developing countries have been impeded by high costs of capital; risk-adjusted return on capital can be up to seven times higher than in developed economies . Ensuring viable returns on investment within reasonable timeframes is a delicate balance that requires innovative financial structures and risk mitigation mechanisms.
Role of sector-specific Financial Institutions
Amid the challenge of scaling up green finance, sector-specific FIs are critical players. Institutions such as REC Limited (REC) and Power Finance Corporation (PFC), which are public financial institutions focused on the power sector, possess a unique advantage. REC is among the first Indian public sector undertakings (PSU) to raise money from international markets through green bonds, amounting to USD 450 million. These have been used to finance solar, wind, and renewable purchase obligations, including refinancing of eligible projects. PFC also issued a USD Green bond in December 2017, raising USD 400 million. Further, in September 2021, PFC issued its first Euro-denominated green bonds, amounting to EUR 300 million, which have financed renewable energy projects. These bonds feature a modest coupon rate and offer a significant avenue for accessing cost-effective funds.
As India shifts to low-carbon energy to meet its environmental goals, PFC and REC can help to mobilize green funds. Their specialized knowledge of the Indian power ecosystem enables them to create innovative financial products tailored to transition projects’ unique requirements. By directing investment to green initiatives, these institutions can drive the transition to cleaner energy, contributing not only to reducing carbon emissions but also to a more sustainable and resilient energy future.
One critical way in which PFC and REC catalyze green finance is through regulatory frameworks and market development. These FIs can design innovative financing instruments that align with the evolving regulatory landscape and market dynamics. By creating products tailored to low-carbon projects, they can attract private investors who may otherwise be hesitant due to perceived risks. This not only increases investor confidence but also contributes to the expansion of the green energy market.
Additionally, PFC and REC’s expertise in risk assessment and mitigation is crucial for advancing green finance. Low-carbon projects often come with distinct risks, ranging from technological uncertainties to regulatory changes. PFC and REC’s in-depth understanding of the sector equips them to assess these risks comprehensively and to design financial products that address them effectively. Such risk mitigation not only encourages investment in renewable energy but also strengthens the overall resilience of the sector.
Furthermore, PFC and REC’s commitment to capacity building adds a valuable dimension to their efforts to catalyze green finance. By providing technical assistance, training, and capacity-building support to project developers, these FIs enhance the feasibility and execution of low-carbon transition initiatives. This not only ensures the successful implementation of projects but also encourages private sector engagement by minimizing uncertainties and boosting the confidence of potential investors.
Partnerships form another essential aspect of how sector-specific FIs like PFC and REC accelerate the mobilization of green funds. Collaborations between these FIs, development banks, and international investors create synergies that leverage expertise and resources. By pooling knowledge and capital, these partnerships enhance the overall effectiveness of green finance initiatives and also amplify the impact of low-carbon projects, creating a more sustainable energy landscape.
As India navigates its energy transition, sector-specific FIs will be of paramount importance. Beyond their roles as financial entities, PFC and REC are instrumental in enabling green finance and accelerating India’s transition to sustainable energy sources. Their ability to innovate, collaborate, and expertly assess and mitigate risks positions them as indispensable catalysts. With their specialized knowledge and commitment to sustainable development, PFC and REC can steer India towards a more resilient and cleaner energy future. As these institutions redefine the financial landscape with innovation and collaboration, India’s quest for sustainability becomes a collective endeavor with a promise of a greener, more prosperous tomorrow.
(This blog is the first in a three-part series on “Transforming India’s Climate Finance through Sector-Specific Financial Institutions.” The second will explore potential financing opportunities and transition risks for these institutions, and the third will present a framework to facilitate flows of global green capital in India via these sector-specific entities.)