Extreme weather events or climate shocks are affecting food inflation. The growing fear is that it is already having a broader impact on the natural rate of interest, thereby influencing the economy’s financial stability, as the RBI’s latest Monetary Policy Report (included in its April Bulletin) points out.
The report goes on to warn that the ‘long-term (economic) output’ could be lower by about 9 per cent by 2050 in the absence of any climate mitigation policies. It ominously adds that “if inflation hysteresis gets entrenched, it may lead to a de-anchoring of inflation expectations, and the undermining of the central bank’s credibility would warrant higher interest rates to curb inflation, leading to greater output loss”.
Given this looming challenge, experts believe that the RBI should follow its peers in advanced economies, most notably the European Central Bank, in helping the formulation of a green taxonomy for the entire Eurozone’s economic value chain. A green taxonomy is a framework to assess the sustainability credentials and possible ranking of an economic activity.
Experts have weighed in with diverse suggestions. Ajay Tyagi, former chairman, SEBI, feels that the foremost thing that is needed to facilitate foreign capital into India’s green sector is to define green taxonomy. “While SEBI’s regulations of 2023 define green security, it is of limited use. In green bonds, the amounts that have been raised are almost outdated – hardly R4,000 crore in written terms. So, unless you define taxonomy, investors would not be sure where their investments are going. Apart from greenwashing concerns, it’s also our responsibility towards the investors to see where they are investing,” he said. For instance, foreign institutional investors planning to invest in India would always compare India’s green taxonomy with, say, that of the EU.
The formulation of a taxonomy code is essential in the context of interest rates set by the RBI. Natural, or neutral, rate of interest refers to the central bank’s monetary policy lever, which allows it to maintain maximum economic output, while keeping a check on inflation. The report mentions a ‘New-Keynesian model that incorporates a physical climate risk damage function’ being used to estimate the “counterfactual macroeconomic impact of climate change vis-à-vis a no climate change scenario”.
Beginning with its July 2022, discussion paper on ‘climate risk and sustainable finance’, the RBI has made incremental progress to address the transition to a green economy, even while admitting that India requires over $17 trillion to achieve its net zero ambitions by 2070.
Green securities
Experts feel that the RBI and the Finance Ministry, after a new government takes over, should take inspiration from the developing world, especially the ASEAN region, where a layered green taxonomy as a living document keeps getting updated with sectoral views of possible sustainable trajectories. While the issuance of R16,000 crore worth of Sovereign Green Bonds and expanding the resource pool by allowing FIIs to participate in future green government securities are welcome steps, the RBI now needs to step on the gas.
For instance, it can undertake a thorough-going assessment on the quantitative and qualitative impact on economic and financial stability due to climate change. It must encourage administrative consultation to begin populating a layered green taxonomy that is reflective of India’s fragmented developmental trajectories. The effort should be to mitigate the transitional risks to the financial system as the economy moves towards a sustainable future, experts aver.
Within the government, the idea is slowly dawning on various key departments. For example, steel manufacturing’s inherent carbon-intensive nature presents a colossal challenge. India’s steel sector stands responsible for 12 per cent of the country’s carbon emissions. The emission intensity, at 2.5 tonnes of CO2 per tonne of crude steel production, overshadows the global average of 1.9 tonnes.
Resource constraints compound these issues. Restricted natural gas availability, reliance on a more inferior grade of iron ore, and a 22 per cent usage of scrap for steel production (compared to a 35 per cent global average) position it at a relative disadvantage.
As part of its push for sustainable growth amidst a booming economy, India is now taking steps to develop taxonomy for green steel, aiming to foster both a market and global standards for eco-friendly steel production. The move is important as India is now the world’s second-largest crude steel producer.
As for the steel ministry, it is hoping that creating a standardised taxonomy will bolster our carbon emissions monitoring, solidify policy-making, and truly incentivise the carbon markets. However, a national taxonomy code is a prerequisite for achieving that goal.
Rakesh Joshi
rakesh.joshi@businessindiagroup.com