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India’s ambitious sovereign green bond programme is navigating uncharted waters, as the government and the Reserve Bank of India (RBI) tread a fine line between achieving the ₹20,000 crore issuance target and capturing the elusive greenium — the prized premium over vanilla government bonds. The auctions in the current fiscal year have showcased a dynamic interplay of market forces, policy manoeuvres, and investor sentiment, underscoring the challenges in building a sustainable green bond market in an emerging economy.
The journey began with high expectations this year, but initial auctions revealed the complexities involved in calibrating yields and ensuring robust demand. In May 2024, a ₹6,000 crore offering with a 10-year maturity was rejected as the government prioritised greenium over subscription, signalling its commitment to price discipline. However, at the subsequent auction in July, the government accepted only ₹1,697 crore at a 6.9 per cent cut-off yield, revealing tepid investor appetite.
The November tranche took an unprecedented turn, with ₹3,497.985 crore of the ₹5,000 crore issuance devolving on primary dealers (PDs) — a first in India’s sovereign green bond history. However, this approach carries risks, as repeated devolvements could erode market confidence and dampen future demand. The decision also sparked debates about illiquidity concerns and the challenges of price discovery in a nascent green bond market. A silver lining appeared in December, when the ₹5,000-crore, 30-year issuance was fully subscribed, buoyed by participation from long-term investors looking for sustainability.
Fragmented liquidity
Yet, the broader narrative remains centred around the greenium conundrum. With issuance sizes capped at ₹5,000 crore per tranche in the second half of this fiscal year, sovereign green bonds lack the liquidity and depth of 10-year tenor benchmark government securities.
Unlike the benchmark 10-year sovereign bonds, which are reissued multiple times under the same international securities identification number (ISIN) and maturity date, often reaching an outstanding issuance size of ₹1-2 lakh crore, 10-year sovereign green bonds are issued in smaller tranches of ₹5,000 crore per ISIN. Subsequent green bond issuances carry different maturity dates and ISINs, fragmenting their liquidity, which has deterred yield-sensitive investors and curtailed secondary market trading volumes.
Adding to the complexity is the absence of institutional mandates or regulatory incentives for domestic investors. Unlike in developed markets, where ESG mandates drive demand, India’s sovereign green bond market lacks dedicated green funds or regulatory nudges for insurance companies, provident funds, or mutual funds to prioritise green investments. This structural gap has amplified price discovery challenges, with auction outcomes often reflecting a tug-of-war between the government’s resolve to maintain greenium and the market’s unwillingness to bid aggressively for a relatively illiquid instrument.
Targeted intervention
To address these challenges and foster a vibrant green bond market, policymakers and regulators must consider targeted interventions. Mandates for institutions like the Employees’ Provident Fund Organisation (EPFO) and insurance companies to allocate a fraction of their investment portfolios to green bonds could significantly enhance demand. Similarly, including green bonds as a fractional fixed percentage under the statutory liquidity ratio (SLR) requirements for banks and other regulated market players could align monetary policy objectives with climate finance goals.
Tax incentives on interest earned from green bonds, akin to exemptions previously available for infrastructure bonds, could attract retail investors. The inclusion of sovereign green bonds in global and domestic ESG indices would further open doors to passive inflows from ESG-focused funds, creating a virtuous cycle of liquidity and demand. Additionally, targeted investor outreach campaigns could bridge awareness gaps and highlight the alignment of these bonds with India’s broader climate goals.
As the government gears up for the final two tranches of this fiscal year — ₹5,000 crore each in January and February — the stakes are higher than ever. These auctions will serve as litmus tests for the market’s evolving appetite and the effectiveness of the government’s strategic adjustments.
Despite the challenges, the government’s commitment to mobilising green capital reflects its larger vision of positioning India as a global climate leader.
(The writer is Managing Partner, Rockfort Fincap LLP)
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