Vulnerable India seeks funding for climate transition

India is one of the world’s most vulnerable countries to climate change. However, its energy needs over the coming decades are huge, driven by high economic growth and a large population, and fossil fuels will remain an important part of the energy mix for some time to come. The financial costs of mitigating climate change are also significantly higher than in developed countries, and major sources of finance are lacking. Developed countries must therefore provide additional funding and make private sector investments in the developing countries less risky.

Brussels Capital 2040

'As the world emerges from the catastrophic year 2039, one ray of hope is the mega-financing deal between the Big 4 (US, China, India and the United Europe). The deal is designed to pull the world out of the vicious spiral of global warming. Devastating climate disasters have once again spared no continent this year[1] .'

This article from the Brussels Capital newspaper of 3 January 2040 makes two things clear: first, by then India will have become a superpower and the G-7 will have been replaced by the Big-4. Second, the negative effects of climate change are systematically increasing. This is the Matthew effect at work: the poorest countries with the fewest resources are hit the hardest, the richest the least. This is clearly illustrated in the attached graph from a study by McKinsey consultants[2] . Without climate action, 160 to 200 million people in India will live in cities where the annual probability of a deadly heat wave is not zero by 2030.

"Poor countries and those dependent on fossil fuels are also the most exposed to the changes brought about by a net-zero transition," the consultants write. "These countries are more exposed to changes in output, capital stock and employment because vulnerable sectors [such as agriculture] make up a relatively large part of their economies." More than 40% of India's population is employed in agriculture. Countries such as the US, Canada and Germany are among the world’s 10 least vulnerable.

India’s high vulnerability

Swiss Re[3] calculates a Climate Economics Index for 48 countries accounting for 90% of global GDP in 2019. What if the average global temperature rises by 2.6 degrees Celsius instead of the maximum of +1.5 degrees Celsius agreed in Paris? The index takes into account (1) the future impact on GDP of physical risks arising from gradual climate change; (2) vulnerability to extreme weather risks (wet and dry conditions); (3) countries' capacity (especially financial) to adapt.

The conclusion? India ranks fourth from the bottom, just ahead of the Philippines, Malaysia and Indonesia. In a 'worst case' scenario, which takes into account the negative impact of 'unknown unknowns' – nobody knows at what temperature defined tipping points will be crossed – GDP in 2050 is 27% lower than that in the Paris scenario. If temperatures rise by 3.2 degrees Celsius, the difference rises to 35 percentage points. According to the International Labour Organisation, rising temperatures in major Asian economies could lead to 10% fewer daylight hours of work by mid-century. Two conclusions: the world is not fair, and doing nothing is not an option (the title of the Swiss Re study).

Warmest, wettest and driest

India is aware of the climate challenge. The RBI devoted an extensive report to the subject in 2022-2023. On page 2, we can read "India experienced the warmest February since statistics began in 1901. [... ] According to the Indian Centre for Science and Environment, in 2022, the country experienced extreme weather events on 314 out of 365 days, resulting in 3026 deaths, the destruction of 1.96 million hectares of cropland, as well as 423,249 houses, and death of 69,899 animals. [...] In 2022, India recorded the seventh wettest January since 1901. March was the third driest and warmest ever in 121 years." The frequency of extreme climate events has almost tripled since 2005.

Surely, when things like this happen, it should be easy to get people to act and implement reforms. "Certainly not," replies Shumita Sharma Deveshwar . "People are used to living in 45 degrees Celsius. If it goes up to 47 degrees, people hardly notice. And even if they do, when you are struggling to feed your family, climate change is not something that is high on your priority list. ?Every year, cities like Mumbai and Delhi are covered in a thick layer of smog. This is partly due to rapid growth, with too many cars and two-wheelers on the roads and traffic jams caused by huge construction projects. Then there is the smoke coming from Punjab, an agricultural state next door to Delhi, where farmers burn the fields after harvest to re-sow as soon as possible."

Schools are closed during this time. More and more children are being born with asthma. "But a real concrete plan from the government to address this is difficult. As I have already said, the government is very sensitive about reforms. They are not going to be quick to impose things that people find offensive. How do you tell people who depend on agriculture that they should stop burning their fields because of climate change? The government is trying to make changes, using large subsidies. But even these things can be difficult for people to understand." ??

Fighting poverty first

This will change once their incomes are higher. "There are enough studies on that," says V Anantha Nageswaran , economic advisor to the Indian government in a speech to the Centre for Social and Economic Progress[4] . "But first, incomes have to be higher to eliminate extreme poverty, poor health care and poor education. Then, as the economy grows, the environment will benefit. Research has shown that richer countries remove more carbon from the air than poor countries." Economic growth increases carbon storage in a number of ways, including better waste management and higher agricultural productivity, which reduces the amount of land needed.

"In addition, one should be careful about using normative terms like 'dirty fuels,'" Nageswaran continues. "No one disputes that dependence on fossil fuels contributes to global warming. But these fuels will remain vital for many parts of the world for decades to come. These fuels are the only way to lift people out of energy poverty and ensure they have the same access to energy as people in the developed world. Access to electricity is necessary to raise the living standards of people in developing countries. And at the moment, the alternatives available are too expensive from fiscal standpoint. So we should be careful about using the word 'dirty' because it gives a strong negative connotation to something that is actually meeting an important need."

Higher costs for low-income countries

A related issue is the cost of mitigation, which is much higher in low-income countries as we move towards a net-zero world. In the McKinsey study cited earlier, we read, "Extremely exposed areas, including sub-Saharan Africa and India, would today need to invest at least one and a half times the amount of more advanced economies as a share of GDP to support economic development and build low-carbon infrastructure." On average, developed countries will pay about 6% of their GDP between 2021 and 2050 to build (only) low-carbon infrastructure. In India, the figure rises to 10% of GDP.?

Developed countries should finance low- and middle-income countries, and do so in a fair way. Professor Raghuram Rajan, former governor of the RBI, has proposed a fair global carbon tax for this purpose[5] . The regions that emit the most per capita – the richest – contribute to a fund that finances or guarantees green projects in the regions that emit the least. "Global per capita emissions are 4.6 tonnes. Those who emit more than the average pay into a global fund; those who emit less receive. " The US emits on average 16 tonnes per capita, so it pays 16 minus 4.6. That's the excess emissions it produces today. We multiply that by 325 million US citizens, plus what I call the global carbon incentive. We set this at $10 per tonne to start with, but it can be increased later if necessary." At launch, the US would pay $38 billion a year into the fund. India, which emits 1.91 tonnes, will receive (4.6-1.9) X 10 X 1.45 billion people = $39.15 billion.?

"If you add up all the amounts from all the big 'polluters', you get about $100 billion," says Professor Rajan. "This is also the aid that rich countries have promised to poor ones." The money India receives can be used to cover the biggest risks of certain projects. This allows it to attract additional money from the private sector. "A leverage of 9 to 1 would not be unusual, providing $1,000 billion in financing," the former IMF chief economist calculates. "These are the sums that start to make a difference in climate finance."

Financing needs

A recent study[6] estimates the additional annual investment needed compared to 2019 for the large group of low- and middle-income countries (excluding China, which can finance the transition itself) at $1,300 billion from 2025, rising to $3,500 billion by 2030. Of this $1,300 billion, a quarter is business-as-usual investments, but with the transition in mind (e.g. the normal investment in expanding generation capacity, now shifted to more expensive renewables). Three-quarters is actually additional financing, of which the authors estimate that emerging markets will need to raise $417 billion domestically and $540 billion internationally (with a public/private split of 2/5 and 3/5 respectively.

So who is investing in India? "Venture capital is important, but we are also seeing investments from listed companies, sovereign wealth funds, pension funds and other institutional capital coming in," says Dr Arunabha Ghosh, CEO of the think tank Council of Energy, Environment and Water (CEEW). CEEW is working on the government’s strategy for rapid transition. "We have already shown that we can quickly scale up from a tiny base to a huge market. Combined with clear policy goals, where states decide they want to commit to green hydrogen or rooftop solar, for example, this becomes an attractive story for investors."

The need for money, manpower and materials

But this is not the end of the transition story. "There are three limiting factors here: money, manpower and materials. The order of importance depends on who you talk to." According to Dr Ghosh, finding suitable manpower is a challenge. Training them will mainly take place within the companies themselves. "Constructors will identify the shortage of materials as the biggest challenge. The government has published a list of 30 critical minerals, some of which we are 100% dependent on imports. We are also dependent on China. So we are now focusing on our own production of solar panels. And on partnerships." For example, there is the 'International Solar Alliance' initiative set up by France and India, now a collaboration of 116 countries; for the import of critical minerals, we are working with other countries like Chile, Australia and so on."

According to Dr Ghosh, money remains the biggest challenge. "Although we are the fourth largest renewable energy market in terms of effective installed capacity, we receive barely 3% of global renewable energy investments. This is because the perceived risk is much higher than the real risk. The risk for investors is higher than the OECD average [because of the not always stable regulatory framework], but the return is also higher. But a bigger problem is currency and interest rate risk. These are risks beyond the control of individual developers. Part of the macro risk lies with the government and the management of the economy. But when the Federal Reserve raises interest rates, it has nothing to do with the state of our economy. But our funding costs for dollar-denominated debt go up."

In Western countries, 80% of green investment financing comes from private sources compared with just 14% in low- and middle-income countries. The average cost of financing the construction of a solar farm, for example, is exorbitant there, with an average interest rate of 10.6%, compared to 4% in the European Union, according to Professor Emeritus Avinash Persaud. According to Persaud, this is a market failure. He proposes the creation of a joint agency of multilateral development banks and the IMF that would reduce these costs through hedging techniques. As a result, he says, many more renewable energy projects will be financed. The idea was put on the table at the G-20 summit in India and is now being taken forward there.

Net zero by 2070

The pledge by the governments of rich industrialised countries to set up a climate transition fund, is a big step in the right direction. "And they are more than right to offer this help," says Dr Ghosh, even if the $100 billion a year is still not there. "The developed world complains that we won’t get to net zero until 2070, and points to the urgency of switching to renewables."? According to the IEA, India is one of the few major economies where coal demand will continue to rise in the coming decades. As a result, its share of global coal demand will rise from 10% in 2019 to more than 15% in 2040.

"Allow me to make a few comments on this," says Dr Ghosh. "First, investment in coal-fired power plants is already falling sharply. In recent months, the central government has cut planned investment in additional coal plants by 10 gigawatts by 2030. They will now be replaced by renewables. By then, coal use will have peaked. Over the past six years, investments in renewable energy capacity have also been much higher than those in coal plants." As a result, coal's share of total electricity generation will fall from 60 to 50% by 2030.

Minimum historical emissions

Why not phase out coal capacity? Because the cost would be very high. For a start, India’s coal-fired power plants are relatively new (less than 15 years old), making it more expensive to shut them down now. "For 'base load' power generation, fossil-fuel plants are still much cheaper for the time being," Dr Ghosh comments, putting him on the same page as economic advisor Nageswaran.

"By 2040, we expect emissions to peak for the whole economy, not just the power sector. Then by 2070, in 30 years, we will be moving towards net zero. This is the shortest timeframe of any major country. European countries peaked in the 1970s, so it is taking them more than 70 years to get to net zero. In the US, emissions peaked in 2006 which is 44 years. In China, it is 35 years."

"That's number one," says Dr Ghosh, now really getting into his stride. "Secondly, what matters for climate change is the concentration of carbon dioxide in the atmosphere. You have to look at the future as well as the past. Our contribution to this historical build-up is minimal. As a result, our total cumulative emissions are 59%, 58% and 49% lower than those of China, US and Europe respectively, even though we do not expect to reach net zero until 2070. I often miss this nuance in discussions about our 2070 net-zero target.”

Mitigation and efficiency

Despite the cash crunch, India has not been idle in recent years. "A climate change action plan was introduced in 2008, with the 'solar mission' as one of its spearheads," Dr Ghosh points out. "In 2010, India had 20,000 megawatts of solar power. Today, it has 70,000 megawatts and 185,000 megawatts of other non-fossil fuel energy. This already makes us the fourth largest renewable energy market in the world."

In addition to mitigation – reducing CO2 emissions – India has been working on increasing energy efficiency in two ways: the first focused on households, the second on the industrial sector. "For households, there has been a massive adoption of LED lights. We skipped some intermediate steps and went straight from incandescent bulbs to LEDs. The government guaranteed the purchase. As a result, the market started focusing on producing cheaper LED lighting, bringing down the cost from 300 to 50 rupees per bulb. In total, more than 600 million LED lights have now been sold, reducing CO2 emissions by 38 million tonnes per year."

For the industry, the Performance Achieve Trade (PAT) scheme has been launched, where energy saving certificates are traded. "Instead of trading CO2 certificates, as in the European Emissions Trading Scheme, the eight largest sectors trade in savings certificates. The regulator sets the required savings for each company. If the company meets its target, it can sell the excess certificates."

This is how India got to where it is today. Renewables and non-fossil energy account for 44% of total generation capacity. Effective power generation is around 20% for non-fossil fuels and 27 to 28% on peak days. "By 2030, we want to have 500,000 megawatts of non-fossil fuel power capacity, which is a doubling of what we have to today and will put us in second or third place." Fifty per cent of the energy needed must come from renewable sources by then. The reduction in energy intensity compared to 2005 will then be 45%.

New initiatives should keep the 2070 net-zero target in sight. Following the success of the PAT, India recently announced the launch of a national ‘Carbon Credit Trading Scheme'. "The implementation of this trading scheme, along with several other climate initiatives, such as the expansion of solar and wind capacity, a gradual increase in subsidies for renewable energy use, progress on green hydrogen production, and higher taxes on pollution, as well as progress on energy storage, are critical," the IMF said in its annual country report[7] . "All of these will help reduce transition costs, expand energy supply, and reduce the health impacts from pollution." The benefits to India of a rapid climate transition are clear. But the country cannot do it alone. Access to additional funding and rapid global technology transfer are essential.

[1] Koen De Leus & Philippe Gijsels, The New World Economy: Investing in Times of Superinflation, Hyperinnovation and Climate Transition, Lannoo, December 2023

[2] McKinsey, The net-zero transition: what it would cost, what it could bring, 2022

[3] 'The Economics Of Climate Change: No Action Not An Option', Swiss Re Institute, 2021.

[4] India in Asia, CSEP, March 3-5, 2023, Neemrana Fort-Palace

[5] R. Rajan, 'Climate Action and Continued Globalisation Joined at the Hip', IMF, (2022 Per Jacobsson Lecture).

[6] Bhattachaya et al (2022)

[7] India, 2023 ARTICLE IV CONSULTATION, IMF Country Report No. 23/426, December 2023