REVISITING RBI’S APPROACH TO SOVEREIGN GREEN BONDS FOR INVESTOR VIABILITY

This post is authored by Abhishek Kajal, 4th year B.B.A. LL.B. student at IIM Rohtak.

1. INTRODUCTION

Green bonds emerged as a source to facilitate capital for funding green infrastructure projects that aim to reduce environmental impact. Hence, when investors purchase green bonds, they are directly supporting projects that benefit the environment.

The Government of India introduced the framework for sovereign green bonds (“SGrBs”) on November 9, 2022 (“2022 Framework”), aligning with the goal of significantly reducing the carbon intensity of the economy. Under this framework, the Reserve Bank of India (“RBI”) has conducted a couple of auctions to raise funds from investors from time to time.

On 13th December 2024, the RBI’s auction of SGrBs marked a significant turning point in India’s green finance journey. After a long time, the auction achieved success with RBI accepting bids totalling the notified amount of Rs 5,000 crores, signalling a departure from its earlier struggles. This shift highlights the need for a deeper investigation into the RBI’s approach to SGrB issuance.

This blog begins by examining the challenges and shortcomings of previous auctions, which saw partial acceptances and cancellations, despite adequate investor interest. Against this backdrop, it then delves into the lessons learned from the December 2024 success and examines international markets like the US to invigorate our Indian framework.

2. THE EBB AND FLOW OF SGRBS

Promising Initial Success

On January 6, 2023, the RBI released a notification announcing the issuance of Sovereign Green Bonds for the first time, amounting to ₹16,000 crores in two tranches of Rs 8000 crores each. The first issue was oversubscribed by more than four times the initial offering. Investors showed substantial enthusiasm, contributing ₹32,892 crores against the auctioned amount of ₹8,000 crores. The cut-off yield was 7.10% and 7.29%, which was lower than the yield rate of normal Government Securities (“G-Sec”) at that time, resulting in a greenium for the issuer.

The greenium, also known as the green premium, refers to the price advantage gained by the issuer (here, RBI) because investors are willing to pay more or accept lower returns to support environmentally sustainable initiatives. In the first issue, the cut-off yield for SGrBs was lower than that of normal G-Sec, thereby benefiting the RBI.

The second tranche of February 2023 also received bids worth around ₹23,000 crores against issue size of ₹8,000 crores, but the cut-off yields of 7.23% and 7.29% were again lower than the prevailing G-Sec rate.

This highlights that despite the strong enthusiasm shown by investors during the initial stages of green bond issuance, as evidenced by the high subscription rates, the issuance has been more beneficial to the government (through greenium) and financially less attractive to investors. Investors indicate to have been driven primarily by the desire to support green initiatives, even though the green bonds were less financially viable for them.[i]

Evidence shows that till this time (February 2023), the total issuance of Indian green bonds amounted to USD 21 billion, however, only 14% was accounted for by Sovereign Green Bonds, while the remaining 86% was dominated by Corporate Green Bonds. Considering that the SGrBs framework was launched only in 2022, this represents significant progress, with two successful auctions conducted by the RBI.

May 2024: Financial viability trumps environmental goals

In May 2024, the RBI had to call off an auction of SGrBs worth ₹6,000 crores. However, the reason was not a lack of sufficient bids but rather that the issue did not provide adequate greenium. The RBI received 99 bids totalling Rs 12677 crores (2x the notified amount), yet it still cancelled the auction, deeming it financially unviable due to insufficient greenium.

This marked the first instance where the RBI’s approach raised concerns, as it appeared to prioritize its own financial benefits over fulfilling the core purpose of the SGrBs framework by significantly reducing the carbon intensity of the economy.  This step indicates a condition to the framework’s objective, implying that carbon intensity reduction would occur only if the government benefited from sufficient greenium. To support this argument, let’s examine further examples.

August 2024: Another sign of issuer reluctance

In August 2024, only ₹1,700 crores worth of bids were accepted out of ₹12,268 crores received against the notified amount of ₹6,000 crores. However, the cut-off yield was 6.89%, which was slightly higher than the G-Sec rate of 6.80%. This is another instance where the auction was partially successful but with minimal greenium. The implication is that investors were unwilling to bid at a price lower than the normal G-Sec rate. As a result, the RBI decided to either partially accept bids or call off the auction.

Following the setback in May and August 2024, the RBI, through its Issuance Calendar for Marketable Securities, announced the auction of SGrBs totalling ₹20,000 crores in the second half of FY 2024-25, divided into four equal tranches of ₹5,000 crores each.

November 2024: Excessive burden on underwriters

After the previous setbacks, the RBI decided to classify 10-year SGrBs issued by the government in the second half of FY 2024-25 as “specified securities” under the Fully Accessible Route. This step aimed to attract foreign investors to bid for SGrBs, as the response to previous issues had not yielded adequate greenium for the RBI.

Despite this initiative, in the first trench of ₹5,000 crores from November 25–29, 2024, bids worth around ₹9,600 crores (>2x the notified amount) were received. The RBI decided to accept only nine bids worth ₹1,500 crores, while the remaining amount was devolved upon the underwriters (Primary Dealers). This led to a cut-off yield of 6.79%, which was again slightly lower than the G-Sec rate of 6.81%.

This is yet another instance where, despite receiving sufficient bids, the RBI chose to accept only a few and shifted the remaining burden onto the underwriters in an attempt to secure greenium. Additionally, the subscription rate of less than 2x this time reflects reduced investor enthusiasm compared to previous issues.

December 2024: A Promising Rise

Finally, in the December 2024 tranche, bids worth approximately ₹15,000 crores (3x the notified amount) were received against the ₹5,000 crores issue. The RBI accepted bids totalling ₹4,998.649 crores, with a cut-off yield of 6.98%, which was at par with the G-Sec rate. This auction was successful and proceeded smoothly because the cut-off rate matched the G-Sec rate. This outcome is a significant takeaway and merits a detailed analysis, which will follow.

3. TACKLING GREENIUM AND TRANSPARENCY ISSUES: A NEED FOR STRUCTURAL ADJUSTMENTS

The Greenium Challenge

All the previous SGrB issues highlight that investors are not willing to pay a greenium to the RBI for investing, and the RBI has repeatedly been partially accepting bids and struggling with auctions. The increased emphasis on greenium has led to decreased enthusiasm among investors compared to the first two issues when the subscription rates were very promising.

This infelicitous approach has also caused investors to shift toward corporate green bonds, which offer better interest rates (more than 8% for 10-year bonds) compared to SGrBs and are more flexible in terms of liquidity.

People typically invest in government securities because they are considered a safer option with lower risk due to the sovereign guarantee. However, this does not mean that individuals will purchase SGrBs even if their returns are less than those of normal G-Sec simply because of the “green” label. Investors require at least comparable liquidity or yields to other government securities (if not more) for these investments to be worthwhile.

The Case of US

The above argument is supported by evidence from the US Green Bond Market. The US has the largest green bonds market, which includes major government-backed securities known as “Use of Proceeds” bonds. These bonds are structurally the same as standard plain vanilla bonds and offer the same financial benefits (such as interest rates) as standard bonds. In addition, these bonds have a “green” label and provide other benefits, such as tax rebates in some jurisdictions.

Furthermore, according to the Green Hand Book for issuing green bonds by the International Finance Corporation, the demand for a green bond will increase if it offers the same financial terms as a regular bond. 

This calls for an important change in the approach by the RBI, where it should focus less on greenium and more on the objectives for which the framework was established. It should restructure these bonds to be at least financially equivalent to G-Sec. The RBI can benefit in the long run by allocating the proceeds to high-term green projects. However, the burden should not be placed on the investors, which could lead to the failure of the auction (as shown earlier).

Communication Gap

Another important issue is transparency and disclosures, which is evident from the fact that the RBI does not provide details of the bidders from whom it has received bids, nor does it disclose whom it has accepted or rejected and the reasons for those decisions. This lack of information demotivates investors, as better disclosures and transparency are crucial for building investor confidence. Bidders need to know why their bids were rejected and whose bids were accepted, along with the reasons for these decisions. The RBI should consider promoting more transparency in line with initiatives recently taken by the Securities and Exchange Board of India (“SEBI”), which has established a mandatory BRSR reporting framework to ensure transparency for investors interested in green investing.

4. WAY AHEAD

The government should also encourage municipal bodies to raise green bonds. In the US, municipal green bonds amounting to US $20 billion were issued in 2023. In India, Some municipal bodies like Ghaziabad, Indore, Vadodara, and Ahmedabad have already raised green bonds over the past five years, totalling around Rs 7 billion. This indicates that there is still significant room for development in this area, and the government can provide proper training and resources to these local departments to make them capable and well-informed in raising funds through green securities.

5. CONCLUSION

The journey of Sovereign Green Bonds in India has been marked by both promising starts and significant challenges. While the initial auctions saw strong investor enthusiasm, subsequent issues have been marred by the RBI’s focus on securing greenium, leading to partial acceptances, cancellations, and a decline in investor interest. The December 2024 auction offers a glimmer of hope, demonstrating that success can be achieved when the cut-off yield aligns with G-Sec rates. Restructuring these bonds to be financially equivalent to G-Secs will make them more attractive to investors, ensuring both environmental and financial viability. This approach can pave the way for a more robust and sustainable green finance ecosystem in India.

[i] Neha Kumar, ‘India’s sovereign green bonds: steps for building on a successful debut’ (LSE, 15 March 2023) <https://www.lse.ac.uk/granthaminstitute/news/indias-sovereign-green-bonds-steps-for-building-on-a-successful-debut/> accessed 17 December 2024.