Reserve Bank of India's Role in Energy Transition

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by KnowESG
KnowESG_Reserve bank of India and sustainable finance
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India's ambitious net-zero targets for 2070 necessitate a massive investment of around US$10 trillion. Achieving this goal requires a collective effort from all financial system entities. The Reserve Bank of India (RBI) is a crucial player whose role in mitigating the risks associated with the transition to a low-carbon economy is increasingly significant.

Highlighting this fact, the recently published report on currency and finance by the RBI emphasises the measures that the central bank can implement to attract investments and expedite India's energy transition, ultimately leading to the achievement of the net-zero objective by 2070.

Leveraging global experiences in growing green finance, the RBI's report draws inspiration from central banks and financial regulators worldwide who have recognised the importance of addressing climate change risks.

Many central banks have established frameworks at both micro and macro levels, integrating climate risks into their prudential approaches and utilising innovative monetary policies to encourage investments in climate-friendly assets.

Taking cues from these initiatives, the RBI's report suggests several monetary policy and prudential regulations that can effectively mitigate climate risks while creating a favourable environment for investments in climate-friendly assets.

The proposals include implementing a scheme to lower borrowing costs for renewable energy firms by extending priority sector lending and providing low-cost funds to banks. Additionally, accepting Sovereign Green Bonds as collateral and adjusting reserve requirements to support credit flows to green sectors are among the proposed measures.

These commendable initiatives position the RBI among the few central banks globally actively pursuing efforts to address climate risks. However, several other levers within the RBI's purview can be used to counter climate risks and unlock both domestic and international capital for low-carbon assets in India.

On the monetary policy front, the RBI has the option to modify the Collateral Framework for Statutory Liquidity Ratio (SLR) for commercial banks in the country. Currently, only state and central government debt qualify as SLR-eligible, excluding corporate bonds. By designating sustainable bonds from top-rated issuers as eligible for SLR, India can give a strong impetus to the domestic sustainable finance market, aligning with global practices.

Regarding prudential regulations, the RBI can establish Countercyclical-Climate Buffers, which would address systemic risks posed by climate change. Basel III norms introduced capital buffers for banks, and implementing a climate risk buffer linked to loan composition would promote lending to low-carbon assets.

To attract foreign capital for the energy transition, the RBI can ease External Commercial Borrowing (ECB) norms by recognising the clean energy sector as a separate industry and relaxing sectoral caps. Additionally, steps can be taken to reduce the cost of currency risk hedging for foreign investors, such as creating a dedicated hedging pool for clean energy companies borrowing through ECBs.

Moreover, the RBI can explore innovative approaches to leverage its forex reserves as an investment catalyst. By strategically allocating a portion of reserves towards risk mitigation initiatives like currency hedging subsidies and credit guarantees, India can attract substantial foreign investment in clean energy infrastructure, given its significant forex reserves.

The pivotal role of the RBI in driving sustainable investments and managing risks in India's transition to a low-carbon economy cannot be overstated. By adopting innovative measures and drawing lessons from global experiences, the RBI can attract capital into climate-friendly assets, supporting India's net-zero goals. Furthermore, the RBI's commitment to addressing climate risks and promoting sustainability will play a crucial role in shaping a climate-resilient financial landscape.

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Source: The Hindu Business Line.

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