World Bank analysis of blended climate finance in India reveals some loopholes

Knowledge gaps among relevant stakeholders, the absence of a regulatory framework and lack of clarity on taxation for blended finance structures are some of the challenges that India is facing, says the World Bank report

The biggest roadblock in achieving climate targets globally is the lack of access to climate finance. India, among other developing economies, also faces challenges to mobilise adequate monetary resources to achieve climate mitigation and adaptation targets. As per estimates in India’s long-term low emission development strategy, submitted to the United Nations Framework Convention on Climate Change (UNFCCC) in 2022, the country needs tens of billions of dollars by 2050 to ultimately achieve net-zero by 2070. Also, based on updated NDCs, India’s adaptation finance requirements stand at around $1 trillion by 2030.

Such a large amount of public funds could be challenging to allocate, particularly when limited resources must be directed towards urgent social needs and emergencies. As a result, private sector investment is crucial to achieving the nation’s climate goals. A new World Bank report looks at an innovative financing instrument— blended concessional finance— that can boost private sector climate-related investments and enhance access to climate finance in India.

What is blended finance?

In simple words, blended finance means a combination of public and private capital. In the words of the World Bank, blended finance combines concessional finance from donors or third parties alongside development finance institutions’ (DFIs’) normal own account finance and/or commercial finance from other investors, to develop private sector markets, address the Sustainable Development Goals (SDGs), and mobilise private resources. Collaboration between public, private, and philanthropic capital is critical for unlocking development gains and addressing massive global challenges such as climate change.

Blended concessional financing possesses the capability to function as a catalyst in numerous solutions, assisting in the removal of significant market obstacles encountered by the private industry. In order to fit the market barrier being addressed, blended finance structures provide adaptable techniques, financial instruments, and assessment procedures.

The report said that these approaches include technical assistance that addresses the risks in new, uncertain, and fragmented markets for investors; risk underwriting that reduces specific risks associated with a transaction; and market incentives that enable emerging sectors to achieve commercial viability. The associated instruments can take the form of senior loans, subordinated loans, equity, performance-based incentives, guarantees or risk-sharing, local currency denominated loans, and risk mitigation guarantees.

However, there are some prerequisites to enable that. 

What is needed for smooth blended finance in India?

The World Bank said that India must establish an investment ecosystem that provides bankable projects, fosters regulatory certainty, encourages financial sector innovation, and undertakes extensive capacity building for all stakeholders.

Crowding in private sector investments, especially in climate-related key sectors, requires de-risking initiatives, including those with uncertain commercial viability and hazards associated with new technology uptake.

Critical areas for climate adaptation or mitigation have been identified in India, and investments related to climate-related blended finance would be given priority in these sectors. The report said that keeping in mind the government’s short-, mid-, and long-term priorities, these highlighted sectors—which include agriculture, land and water management, power, transport, infrastructure, health, industry, and the circular economy—align with India’s net-zero ambitions.

The regulatory environment pertaining to finance has been maturing to keep pace with the changing needs of the global economy through reforms and ease of doing business measures. Most recently, the Reserve Bank of India (RBI) joined the Network for Greening the Financial System (NGFS) in 2021, and in May 2022 the Securities and Exchange Board of India (SEBI) constituted an advisory committee for environmental-, social-, and governance-related matters in the securities market. 

However, some regulatory challenges remain in the blended finance ecosystem.

Key challenges to incorporate blended finance in India

The report pointed out several challenges standing in the way of blended finance actualising its potential in India. The country’s regulatory framework draws a clear distinction between funds that are deployed for not-for-profit (i.e., environmentally beneficial in this context) versus for-profit activities. Funds that are classified under the corporate social responsibility framework are not allowed to seek return on capital. Similarly, commercial enterprises face challenges with respect to taxation and accounting when they invest in not-for-profit activities. World Bank said that regulatory amendments and clarifications are needed to allow easier blending of commercial capital with concessional sources in order to de-risk investments.

Then, a lack of standardised blended finance framework and associated knowledge gaps emerge as big challenges. Given the limited scale of blended finance transactions in India, market players lack adequate knowledge and experience in structuring these deals. Most deals must be individually tailored, which increases their overall cost and makes the process cumbersome. The specialised knowledge required for tailoring and structuring such deals is not easily available. The report recommended that creating open-source platforms can help share knowledge, experience, and lessons among investors, philanthropists, foundations, governments, and donor agencies.

The absence of an impact assessment and measuring framework is another major barrier to expanding blended finance usage and volume in India. As only measurable assets are funded by investors, it is necessary to create a framework for efficiently showing impact. It would entail formulating a concise impact thesis, mapping partners’ impacts, increasing data capacity, and creating instruments for gathering data. 

Steps to improve enabling environment

According to the report, the development of a green taxonomy that provides a common, benchmarked, and agreed-upon language and a clear definition of what constitutes “climate”, “green”, and “sustainable” finance is critical. While trying to calculate the extent of climate finance flows, it is important to take into account that flows are new and additional rather than reassigned flows from other development projects to climate action; climate-specific; grants or at concessional rates or otherwise at a lower cost. As of June 2022, a multilaterally agreed definition of climate finance is elusive, and a standing committee of finance in the UNFCCC is working on this.

Introduction of innovative instruments such as risk-sharing facilities is needed, added the report. Risk-sharing facilities are useful in promoting portfolio expansion in a sector such as climate related investments, which is either new for a financial institution or is associated with a higher degree of credit risk. Currently, there is no enabling regulatory framework under the Foreign Exchange Management Act, 1999, and related exchange control regulations pursuant to which DFIs can offer this in India. Such a framework could go a long way to de-risk decarbonisation and help mobilise capital for investments.

And finally, the report said there’s a need to provide clarity on withholding tax for providers of concessional finance. There are various providers of concessional finance including DFIs, impact funds, philanthropic capital, and private sector investors. Multilateral DFIs typically have tax exemptions, including in respect of withholding tax, under applicable treaties and related national laws that cover the blended finance products that they offer. However, the tax regime differs significantly across the various other entities, and blended finance products offered by impact funds or other entities may not be exempt from tax. Therefore, to ensure that concessionality is not diluted and a level playing field is maintained, it is critical to have clarity on necessary tax exemptions.

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