India’s financial sector is extremely vulnerable to the risks of a low-carbon energy transition, but despite this, only one in six finance professionals in India is according to a new paper published in a leading journal. Has experience identifying and managing those risks.
In 2021, Prime Minister Modi committed to reach India’s target of net zero emissions by 2070. A transition to a net-zero economy would reduce climate change impacts, but reduce the profitability of polluting firms and create stranded assets. Only four out of ten major financial institutions surveyed collect information on ESG risks. Furthermore, these firms do not systematically use that information to make financial decisions. Also, high carbon industries – power generation, chemical, iron and steel, and aviation – represent 10% of the outstanding debt to Indian financial institutions.
These industries are also heavily indebted, and hence have less financial capacity to respond to any kind of financial shocks and stresses. Coal currently accounts for 44% of India’s primary energy and 70% of its electricity generation.
The average age of the country’s coal-fired power plants is 13 years. New proposed coal capacity of 91GW is underway in India. This brings India to the second position after China. As per the Draft National Electricity Plan 2022, the share of coal in electricity generation is expected to decline to 50% by 2030 as compared to the current contribution of 70%.
At the same time, if we talk about achieving India’s climate goals, it is necessary that many of the planned coal plants are not built. Also, achieving the 1.5°C target requires that unsustainable coal plants be retired by 2040, even if they are still technically viable. The new analysis also shows that only about one-sixth of power sector lending is purely for renewable energy.
“Financial decisions by Indian banks and institutional investors are ensnaring the country into a more polluting, more expensive energy supply. For example, we find that only 17.5% of loans to the power sector are purely renewable energy. As a result, India has a much higher carbon electricity footprint than the world average, despite its vast potential for cheap solar, wind and small hydropower. Shifting resources towards these renewable sources will bring huge benefits like cheaper electricity, cleaner air and lower emissions.”
The report comes as the auction of 5-year and 10-year green bonds worth Rs 40 billion is to be held shortly, on January 25 and February 9, 2023. Here India has also achieved the presidency of the G20. Mapping India’s policy commitments against all of this lending and investment patterns reveals that India’s financial sector is highly exposed to potential transition risks.
Neha Kumar, Head, South Asia Programs, Climate Bonds Initiative, says, “The Reserve Bank of India through its July 2022 Discussion Paper has recognized the transition risk for the Indian banking sector and has included climate risks in its stress tests and disclosures. The guidelines have been laid down for the regulated entities on integration of
Financial institutions will need to scale up their capacities relatively quickly as the RBI is moving in this direction. The other side of the risks is the tremendous opportunity to shift finance towards sustainable assets and activities. Strong, internationally interoperable taxonomies play a huge role in guiding finance reliably. The draft taxonomy of the Ministry of Finance, developed in 2021, awaits its release. This will give a big boost to realize the huge potential for green finance in India.”
The study also takes a look at the value of outstanding corporate bonds in sectors with high transition risk. These sectors are home to many blue-chip companies that dominate India’s debt markets and thus account for a large portion of outstanding Indian corporate bond issuance: INR 4.4 trillion by 2021 out of INR 40.2 trillion by 2022. The largest issuers of corporate bonds, with outstanding bonds of ₹1.9 trillion (US$25.9 billion) by June 2021, include carbon-intensive sectors such as oil, gas and consumable fuels.
40.8% of bonds issued by oil, gas and consumable fuels are denominated in foreign currencies, which are more likely to be held by foreign investors. However, 90.5% of the bonds issued by power utilities are in Indian Rupees. These results imply that the portfolios of domestic financial institutions are significantly exposed to transition risk given the large share of domestic currency corporate bonds issued by the power sector and account for four-fifths of lending to the sector. Flows to utilities that generate electricity substantially or exclusively from fossil fuels.