Financing India’s Green Transition: Challenges and Pathways #IndiaFinance

Recent global developments–including the contentious ‘agreement’ on climate finance at the COP29 summit in Baku, Azerbaijan, and the United States’ withdrawal from the Paris Agreement, followed by significant reductions in development aid via United States Agency For International Development (USAID)–have raised serious concerns about the reliability of international climate finance for essential mitigation and adaptation efforts in the Global South. These developments strongly suggest that financial support from the Global North for climate-related investments will remain constrained, at least for the foreseeable future.

India’s Industrial Transition: Challenges and Dependencies

According to a report by India Briefing, the industrial sector contributes 27.63% to India’s Gross Domestic Product (GDP). Deep decarbonization of this sector–particularly in hard-to-abate industries such as steel, cement, and aluminium–depends on technological advancements that are either in early development stages or not yet commercially viable. Moreover, the uncertainty surrounding financial returns from investments in unconventional technologies heightens the risk for lenders. This results in increased borrowing interest rates and the imposition of stringent covenants of lenders including stricter collateral requirements, shorter loan tenors, and other financial safeguards. These conditions often deter potential borrowers to undertake large-scale transition projects using borrowed capital.

Financing Constraints

With diminishing foreign aid, developing nations such as India are increasingly compelled to rely on commercial sources of finance to fund transition efforts in the industry sector. Ensuring that such investments generate sufficient returns will require access to affordable and flexible commercial financing.

However, Indian banks operate under a stringent regulatory framework established by the Reserve Bank of India (RBI). These standardized operating frameworks allow limited room for discretion in credit appraisal, risk assessments, and lending practices thereby allowing little flexibility and subjectivity to deviate from the established processes and guidelines. Consequently, the financial feasibility or ‘bankability’ of several climate-related transition funding proposals remains uncertain, as they lack a reliable cash-flow plan to conclusively establish their viability. This makes funding from banks and capital markets essential to enable sustainable and financially viable transition.

Debt Markets and Limitations

The debt capital market in India is relatively underdeveloped. Unlike in developed countries, corporate bond markets in India remain accessible to only the highest-rated issuers with most offerings in the ‘vanilla’ category lacking innovation, complexity, and variety. Moreover, overreliance on domestic institutional investors, such as insurance companies, provident funds, and mutual funds that operate under strict investment guidelines and guardrails further restrains access to a larger base of potential borrowers.

Foreign investors including hedge funds, private equity, family offices, sovereign wealth funds, and pension funds generally follow asset allocation strategies for emerging markets (EM) rather than country-specific mandates. While India remains well placed in terms of the future growth outlook aided by consistent policy support, it faces stiff competition from other EM economies. In today’s high-interest-rate environment and amid global uncertainty, the risk-adjusted returns from EM assets often fall short of investor expectations, thereby discouraging increased allocation to ‘riskier’ markets like India.

India’s current sovereign ratings–BBB- by Fitch and S&P Global and Baa3 by Moody’s–place it at the lowest tier of investment grade. Although its equity markets are fairly deep, with significant participation from foreign institutional investors (FIIs), domestic institutional investors, and retail investors, private investment in emerging mitigation and adaptation sectors continues to face significant barriers. These include high upfront costs, technological and market uncertainties, and regulatory unpredictability. A lack of well-structured, bankable projects along with a supportive policy environment, further restrict private sector engagement.

Policy Efforts and Gaps

Over the years, there have been regulatory and policy initiatives undertaken by the Indian government. In 2011, the Climate Change Finance Unit was formed within the Ministry of Finance. In 2012, Securities and Exchange Board of India (SEBI) mandated the top 100 listed entities to publish annual Business Responsibility Reports. In May 2017, SEBI issued guidelines for green bond issuance that specified the disclosure requirements. The RBI has ensured that under priority sector lending, a certain portion of bank loans gets directed toward sectors such as the small renewable energy sector.

Yet, structural challenges remain. For instance, SEBI regulations mandate that all investors (Limited Partners or LPs) within an Alternative Investment Fund (AIF) must be treated equally with respect to economic rights. AIFs benefit from a diversified LP base comprising both risk-averse investors willing to accept lower returns and risk-tolerant investors targeting higher yields. This allows the investment manager to diversify and blend the fund. SEBI, however, argues that instead of having varying risk appetites for different LPs, managers should launch different schemes to cater to the needs of each LP class. As noted by legal experts at Nishith Desai Associates, this position disregards the administrative costs and challenges involved in launching new fee structures that would ultimately be passed on to the LPs.

The Way Forward

To unlock greater flows of commercial and private capital for climate transition, regulatory constraints need to be re-evaluated by key institutions, such as the RBI and SEBI. Only through bold financial sector reforms and innovative policy mechanisms can India mobilize the scale of investment required for a just and sustainable transition.