How shifting to green bonds can help shape India's transition

An oil bond is an IOU or a promissory note issued by the government to oil marketing companies (OMCs) – it promises a definite amount of money at a specified future date. When fuel prices rise, the OMCs would not pass the additional burden to the customer in return for this bond which acts as a guarantee by the government. The government would bear this difference, which would be paid over a period of many years.

In 2010, petrol prices were deregulated and OMCs were free to fix the price based on market rates. Between 2005-2010, global oil prices had reached a record high. In order to avoid burdening consumers to pay the entire amount, the Indian government directed OMCs to sell the petroleum products at earlier rates. The difference between the actual price and the subsidized retail price would be borne by the government.

If the government attempted to reimburse this difference immediately, it would have led to an increase in the government's fiscal deficit and diverted the funds from other welfare measures. After the 2008 global financial crisis, it became even more critical for the government to utilize its limited financial resources to boost economic activities.

Under such conditions, the United Progressive Alliance (UPA) government decided to issue oil bonds. The government issued these oil bonds from 2005-2010 and promised to reimburse OMCs over 15-20 years. In 2014, the National Democratic Alliance (NDA) came to power and inherited 1.34 lakh crores of oil bonds payable till 2026. Of these, only 13,500 crores (10%) were paid by the end of 2021. Revenue from this sector (6.7 lakh crores in the fiscal year 2020-2021) and higher fuel prices made the average yearly payout on oil bonds a manageable number (12,000 crores per year). But, this leads to the unavoidable dilemma for any government: should it use the revenue to repay old debts or to boost economic activities in the country?

No. Another reason is India’s high oil imports. As more than 80% of domestic demand is fulfilled by imports, any change in global petroleum prices directly affects India. The Russia-Ukraine war has disrupted the hydrocarbon supply chain and caused fuel prices to skyrocket.

Such vulnerability to global dynamics highlights the need for India to reduce import dependency and explore biofuel options that can be developed indigenously. Green infrastructure and projects that support such initiatives can be funded through green bonds.

A green bond is a fixed-income instrument specifically dedicated to raising money for climate and environmental projects. Green bonds are asset-linked and backed by the issuing entity's balance sheet. They work just like any other corporate or government bond. The first green bond was issued in 2007 by the European Investment Bank, followed by the World Bank in 2008. Since then, the World Bank has become a significant issuer of green bonds and has issued 164 such bonds worth $14.4 billion.

India's first green bond was issued by Yes Bank in 2015 to raise INR 5 billion to enhance long-term resources for funding infrastructure projects in renewable and clean energy. Despite the green bond issuance in India in 2021 being a remarkable INR 6.11 billion, it is only 0.7% of the Indian bond market and dwarfs in comparison to the global green bond issuance.

Foreign investors scout for green bonds issued by growing markets like India as they have attractive valuations and good growth prospects. If marketed correctly, green bonds could bring in a new set of investors to India’s debt market.

Green bonds, although a great alternative to oil bonds, come with a few challenges.

Firstly, if the government wants to go global to raise funds, India needs to improve its credit rating as all bonds issued globally are closely linked to the credit rating of the issuing country. This could mean close scrutiny of the domestic policies, which the government should be transparent and open to. Secondly, the monitoring of such green projects needs to be stringent to ensure better completion rates. Recipients of such funds should be compliant, and a penalty component could be imposed in case of missing a deadline.

Lastly, the coupon rates of a green bond are not easy to determine as there are constant debates on whether to price them higher or lower than regular bonds with equal arguments on both sides.

Creating green infrastructure would require investment and involvement of multiple stakeholders. Globally the green bond market should have adequate support from both the public and private sectors of all nations and from the institutions like World Bank for capacity building and expertise in green projects.

A robust green bond market would further require common standards and guidelines for it to be connected to the mainstream capital markets and investors. This will help in channelling the capital towards sustainable development. It makes sense for governments to promote green bonds over oil bonds in the interest of sustainable economic growth.