In Need of Climate Finance: size and magnitude

The net-zero emissions trajectory set by many countries including India, cannot be achieved without adequate financial resources. IEA (2023) estimates suggest a sizeable magnitude of clean energy investment to be made to meet stated goals of net zero by countries. Projections indicate that it has to be tripled by 2030 and further to be scaled up by five times annually from 2030 to 2050 to keep countries on net-zero trajectory. Other estimated numbers indicate the ballpark figure to be around USD 8 to 9 trillion dollars by 2030 (Monar, 2024a). These projected figures may escalate to new highs depending on the degree of climate inactions and future uncertainties associated with climate hazards. India is no exception to these realities. Our country is highly vulnerable to climate hazards due to its unique geography characterized by highly fragile mountainous regions like the Himalayas and long coastlines prone to cyclonic disturbances and storm surges. Studies point to the fact that 80% of the districts in India are highly vulnerable to climate hazards and extreme climate conditions (Mohanty and Wadhawan, 2021). Given the degree and intensity of climate vulnerability, the size of climate funds required for meeting the climate-related costs is projected to be quite humongous. In order to achieve Net-zero Goal by 2070, India requires a sizeable quantum of funds estimated to be around USD 10 trillion. Even the much prioritized and policy emphasized energy transition implementation trajectories require more than 2 trillion USD for the country (Singh, et al., 2024). However, there is a significant dearth of the required funds to meet such ambitious climate goals for the country. Though there has been a rise in the climate funding flows in recent years mostly directed towards climate mitigation activities, it still constitutes only 1% of the global gross domestic product or GDP (CPI 2023). It is contended that the current climate financing options from all possible sources in India could only meet a meagre 25% of its total climate finance requirements.  The funds shortfall is often attributed to the credit market failure conjugated with issues with priority sector lending by the Reserve Bank of India (RBI) (Bhatnagar and Sharma, 2021) and further accentuated by high-capital costs of such investments combined with high costs of borrowing for green projects and technologies (Dhruba, 2018). Besides, the funds shortfall may be further accentuated by the recent global developments. Apprehensions run that pulling out from Climate Accord by US would further jeopardize the effort to mobilize the required resources for climate change at the global scale. This may have repercussions for India's effort to source international as well as domestic funding for climate change. 

Nature and Character of Climate Finance

While the global financial commitments with regard to funds flow to developing countries decided at COP29 Baku through the mechanism of New Collective Quantified Goal (NCQG) got caught in the controversy with regard to the nature and size of the funds, similar uncertainties exist with regard to the future funds flow for climate actions in developing countries. The current framing of climate finance source apportions indicates that funds flow from multiple sources including budgetary support from both the federal government and subnational governments, loans, and grants from banking and non-banking financial institutions, funds mobilized from financial markets such as bonds and equity markets, resources sourced from private investors and through innovative financing routes such as crowdfunding. Climate finance strategy, in the Indian context, largely revolves around four key sources of funding—mobilization of private sector funding, funds drawn from international institutions and partnerships, funds mobilized through a blend of innovative financing, and other climate innovative financing (Suri 2023). Within these, private financing is increasing, taking the centre stage as a core source of financing, given the budgetary constraints being increasingly felt with the public exchequer and limited funds flow from the multilateral and bilateral international bodies. However, it is strongly put forward that in order to spur private investments, adequate incentive mechanisms are to be brought in place by the public authorities to materalize the crowding in effects of government funding. For instance, renewable energy investments, which are largely private investor driven, both globally and in India, are primarily incentivized by the public authorities.

Whether Carbon Market Could be a Source of Climate Financing?

While the potential of the private sector in mobilzing climate financing is proven, of late, the role and importance of carbon market as a potential source of climate financing has received a renewed thrust after its adoption in COP29 in November 2024. It is asserted that if effectively designed, carbon markets could be a prospective source of climate finance while meeting the emission reduction goals (Monar, 2024b). It is argued that mechanisms through which the carbon credits could support the financial requirements for climate change would depend on the regulatory architecture of the country and the typology of carbon market, that is, voluntary or regulatory. The revenue gathered through the carbon financing mechanisms could augment the fiscal space for the country governments, which is much needed particularly in developing countries like India which encounter budgetary constraints for supporting the climate finance requirements. Available statistics indicate that around 74 carbon-pricing instruments have been introduced in various countries worldwide and the total revenue generated through these sources is close to USD100 billion in 2022, a four-time jump from a value in 2015. Country-specific emission trading schemes (ETS) have emerged as an effective source of mobilizing climate finance in many countries (Singh, et al., 2024). For instance, selling of emissions allowances through auctions could act as a source of revenue for the government (Burtraw and McCormack, 2017).  It is reported that EU-ETS has generated more than USD200 billion through auctioning of emission allowances since 2013. The collated amount has been spent on various climate and energy purposes by member states and supported in creating various funds at the centralized level such as modernization fund's for accelerating energy transition, innovation funds for promoting low-carbon innovative technologies, and social impact funds for extending the much-needed support for poor and vulnerable households.  In similar vein, several other country-level and regional ETS schemes such as Japan ETS and California Cap and Trade Programme, The Washington State Cap and Invest Programme and Regional Greenhouse Gas Initiative have used the proceeds collated through allowances in supporting climate actions. For example, Japan has an ambitious plan to generate $120 billion through the auction of power sector allowances to be spent through Climate Transition Bonds.

Can India Use Such a Market Form as a Source of Domestic Climate Finance?

Though, India is the third-largest emitter globally in absolute terms, per capita emissions in the country is less than half of global average with 1.8 tonnes of CO₂ per person. Total emissions of India constitute 8% of the global emissions, approximated to be 4 billion tonnes of CO₂, though the share of cumulative emissions is much lesser. While emissions are projected to rise for India by 30% by 2050 (IEA, 2023), the question is whether the conventional emission financing is adequate and what alternative options are available for financing of emissions. It is posited that innovative financing sources such as carbon markets could act as an additional source of financing.

India's proposed Carbon Credit Trading Scheme (CCTS) is a pivotal step in leveraging market-based mechanisms to combat climate change impacts and attract climate financing. Proposed under the Energy Conservation (Amendment) Act, 2022, the scheme aims to create a robust domestic carbon market where businesses and entities can trade carbon credits. Unlike earlier initiatives like the Perform, Achieve, and Trade (PAT) scheme, which was limited to energy efficiency, this broader framework extends to various sectors and aligns with global carbon trading mechanisms under the Paris Agreement. This trading system not only enables India to meet its Nationally Determined Contributions (NDCs) but also attracts investments in sustainable technologies. By pricing carbon, the scheme sends a clear signal to industries to innovate and transition towards low-carbon operations.

However, given that India is entering to its own domestic carbon market and structuring it alignment with Article 6 of the Paris Agreement, a successful design and operation of such market needs to be aligned with the domestic CCTS market. Central Government on the basis of recommendations of NDAIAPA has approved the list of 14 activities under Article 6.2 mechanism which can be considered for trading of carbon credits under bilateral/cooperative approaches. These activities will facilitate adoption/transfer of emerging technologies and may be used to mobilize international finance in India. This will enable setting up of projects in sectors with emerging/ cutting edge technologies and/ or high investments. This will facilitate viability gap funding resulting in adoption of these technologies and bringing economies of scale.

Another important question is how to use the proceeds generated through the carbon revenue. It has been emphatically pointed out that the use of the proceeds generated through the carbon revenue shall be used carefully, largely depending on the context. India's CCTS can drive climate action by channelling proceeds into renewable energy projects, energy-efficient technologies, and climate adaptation measures. These funds should also support green technology R&D, subsidies for SMEs, and sustainable initiatives to ensure an inclusive and low-carbon economy.

Under Article 6.4 of the Paris Agreement, 2% of the proceeds from carbon credit transactions are mandated to be contributed to the adaptation fund. Additionally, a separate 5% of issued credits is set aside and cancelled to ensure an overall climate benefit, further reinforcing the mechanism's goal of supporting both mitigation and adaptation efforts. Hence, the potential of carbon market as a source of climate financing for India is quite huge.

References

Bhatnagar, S. and D. Sharma. 2021. Green financing in India: identifying future scope for innovation in financial system. International Journal of Green Economics 15 (3):185–212

Burtraw, D. and  K. McCormack. 2017. Consignment auctions of free emissions allowances. Energy Policy, 107 Climate Policy Initiative (CPI). 2023. Global landscape of climate finance 2023. Details available at <https://www.climatepolicyinitiative.org/wp-content/uploads/2023/11/Global-Landscape-of-Climate-Finance-2023.pdf> Cramton, P. and S. Kerr. 2002. Tradeable carbon permit auctions: how and why to auction not grandfather. Energy Policy 30: 333–345

Dhruba, P. 2018. Managing credit risk and improving access to finance in green energy projects. ADBI Working Paper. No. 855

International Energy Agency (IEA). 2023. Net zero by 2050. Details available at <https://iea.blob.core.windows.net/assets/deebef5d-0c34-4539-9d0c-10b13d840027/NetZeroby2050-ARoadmapfortheGlobalEnergySector_CORR.pdf>

Monar, D.C. 2024a. Carbon pricing revenues: their role in financing the climate transition. Institute for Climate Economics. Details available at <https://www.i4ce.org/en/carbon-pricing-revenues-role-financing-climate-transition/>

Monar, D.C. 2024b. Maximizing benefits of carbon pricing through carbon revenue use: a review of international experiences. Details available at <https://www.i4ce.org/wp-content/uploads/2024/05/Maximising-benefits-of-carbon-pricing_27june.pdf>

Mohanty, A. and S. Wadhawan. 2021. Mapping India's climate vulnerability: a district-level assessment. New Delhi: Council on Energy, Environment and Water

Singh, N., A. Ritchie, and Y. Chen. 2024. Financing just transition through emission trading systems: challenges and opportunities for India. The Asia Society Policy Institute 

Suri, A., 2023. A comprehensive framework for India's climate finance strategy. Details available at <https://carnegieindia.org/2023/03/16/comprehensive-framework-for-india-s-climate-finance-strategy-pub-89270#:~:text=This%20article%20argues%20four%20key,financial%20instruments%2C%20and%20innovation%20finance> #