- Climate change is in focus in the Reserve Bank of India’s latest Report on Currency and Finance (RCF) which highlights the role of fiscal policy in driving energy transition and investments.
- The report examines the complex and non-linear ways in which climate, economy, financial systems and related policies operate and discusses the role of central banks, such as the RBI, in climate action.
- It says that a sector-specific approach to green transition can succeed only if reasonable and sustained progress is achieved across all key carbon-emitting sectors.
The Reserve Bank of India (RBI) has focussed on climate change as the primary theme in its Report on Currency and Finance (RCF) for 2022-23, a theme-based annual report on contemporary issues concerning central banking and macroeconomic issues in India. This year’s report emphasises climate goals as a policy priority and analyses the potential macro-financial consequences of climate change for India.
The theme for this report, published on May 3, is “Towards a Greener Cleaner India” and it claims that fiscal policy has a prominent role in driving the green transition, from fossil fuels to renewables, and highlights the urgent need for a green taxonomy, a classification system that determines whether an investment is sustainable or not. India has prepared its green taxonomy but has not released it yet, says experts who were part of the report preparation.
The report looks into the physical indicators of climate change and policy action globally and in India. It goes on to discuss the macroeconomic effect of climate change in India, climate change and the financial sector, and policy options to mitigate climate risks.
“India’s goal of achieving the net zero target by 2070 would require an accelerated reduction in the energy intensity of GDP by around 5% annually and a significant improvement in its energy mix in favour of renewables to around 80% by 2070-71. India’s green financing requirement is estimated to be at least 2.5% of GDP annually till 2030,” says the report, quantifying the scale of the effort needed towards climate action.
It also discusses the role of central banks, such as the RBI in India, in dealing with climate change. “There is a growing recognition that even if governments are the most influential agency for climate change, all institutions, including central banks and financial sector regulators, are stakeholders, especially in view of the existential threat to their central mandates,” it says. The report is put together by contributors from the Department of Economic and Policy Research (DEPR), a knowledge centre for macroeconomic policy research at the Reserve Bank of India.
Reacting to the RBI’s report that picks climate change as its central theme, Suranjali Tandon, assistant professor at the National Institute of Public Finance and Policy (NIPFP), says that RBI is taking a gradual and phased-manner approach to streamline green finance. Earlier, it published a report on climate-related financial risks and then a report recently on green deposits as an instrument to address climate change. Now, with the new RCF focusing on climate change too, the consistent attention to climate change in RBI reports indicates the mainstreaming of the subject, she noted.
RBI, so far, has been playing the role of a regulator of the financial system while managing inflation. It plays a regulatory role in minimising financial risk, she says, adding that RBI thus has to assess the physical and transition related risks on financial assets.
Climate risks may threaten financial stability
Financial stability, the core mandate of central banks around the world, can face risks due to climate change, says the RCF report, as it can affect the valuation of financial assets by influencing investors’ risk perceptions.
The pressure of currency depreciation in countries frequently affected by climate disasters can cause financial instability, higher import costs, and negative terms of trade. In this context, central banks around the globe are gradually broadening their objectives beyond the original scope or focus, the report says.
Giving other examples of how climate change can affect inflation and financial assets, the report says that climate change can affect price stability through supply shocks such as food and energy shortages.
Additionally, demand shocks can arise when firms and households lose wealth on account of frequent natural disasters. Physical and transition risks can affect the balance sheets of financial institutions and banks, limiting the flow of credit to the real economy. The report says climate-induced uncertainty can make households save more for precautionary purposes, bringing down the real equilibrium interest rate, which is the interest rate at which the demand for money matches the supply.
Impacts on sectors
The report discusses different sectors – electricity, mobility, industrial, agricultural – and the impact of climate change in each. It also highlights sectoral green transition challenges.
The report says that the industrial sector is the most difficult to decarbonise as it is highly energy intensive and also has a large, fixed investment. Decarbonisation in this sector would require major changes in production processes, expensive retrofits, development, and deployment of new technologies, as well as changes in business practices and policies.
Regarding agriculture, the report highlights a pattern of climate change’s impact on the sector, saying that it is more visible in horticulture, especially perishable products like vegetables because horticulture crops are more exposed to extreme weather events. In comparison to this, the impact on foodgrain production seems mild, perhaps because foodgrain production is geographically well distributed, and the nature of climate events is also localised.
Further, the report notes that in addition to being impacted by climate change, agriculture is a significant contributor to greenhouse gas (GHG) emissions. In India, the agriculture sector is responsible for approximately 14% of GHG emissions. Additionally, this sector consumes about 17% of the total electricity utilised in the country and around 5.9 lakh tonnes of diesel, primarily used to power the 20 million water pumps across India.
The report says a sector-specific approach to green transition can succeed only if reasonable and sustained progress is achieved across all key carbon-emitting sectors, which would need active participation by all stakeholders, ranging from state and local governments to private corporates and NGOs.
Mitigating impacts of climate change
The report says a successful transition to a net zero economy would need deep decarbonisation of all carbon-emitting sectors such as power, transportation, industrial production processes, construction activity, and agriculture. Beyond this, it also emphasises nudging citizens to change their lifestyle habits and consumption preferences.
Of India’s current annual carbon emissions, about 40% could be addressed by replacing fossil fuels with renewables and another 15% by switching over to electric vehicles (EVs) and energy-efficient electrical appliances in residences and business establishments. The remaining 45%, however, are emissions from hard-to-abate sectors, such as heavy industries, animal husbandry, and agriculture, the report says. “They are hard to abate because either technology to support the green transition is not available, or the cost is prohibitive,” it explains.
The report talks about appropriate carbon pricing that would be critical to reducing carbon emissions by 80% by 2050. India’s Energy Conservation (Amendment) Act 2022 recognises the importance of carbon pricing and aims to develop a carbon market or an emissions trading system (ETS).
The report says, “Carbon taxes are expected to shift power generation from coal towards renewables while supporting public revenue mobilisation and bringing down the distortionary effects of other taxes.”
Mitigation, adaptation, and disaster management will require huge resources, and India will have to arrange new investments estimated to be in the range of $7.2 trillion to $12.1 trillion by 2050, it underlines.
Another challenge, it highlights, is access to technology and minerals. Increasing dependence on new technologies used in batteries; solar panels and wind turbines; green hydrogen; carbon capture, utilisation, and storage (CCUS); and e-waste management would require higher expenditure on research and development (R&D) and strategic collaboration, it says and goes on to discuss a different financial mechanism to mobilise the finance.
A visiting fellow with Observer Research Foundation (ORF), Srinath Sridharan says that RBI has set the tone and pace for climate resilience conversations, be it highlighting the climate risks and adaptation challenges, the ideas around climate financing, or the need for ESG standards. RBI emphasised the need for all the stakeholders to collaborate, be it policymakers, civil society, corporates, financial institutions, academia, and new economy innovator industries.
The challenge, however, seems to be from the user sectors, says Sridharan. With the Government of India’s positive and proactive climate initiatives, and with RBI showcasing its policy thought leadership, the industrial sector is a laggards, he says, adding that the financial institutions who have been doing lip service to the concept of climate, green & ESG, now have to quickly undertake their biggest change management institutionally. This RBI report is a good reminder for them, he said.
Banner image: Transporting a wind turbine blade. Photo from Pxshere.