Gift City sovereign green bonds face currency hurdle

While all Indian government securities are issued in rupees, foreign investors were hopeful that the bonds sold in Gift City would be in dollars. That is because its goal is to be "a jurisdiction that provides financial services to non-residents and residents (institutions) in foreign currency other than rupees".

“As the debt manager to the government, the Reserve Bank of India (RBI) does not want to issue sovereign securities in dollars. The problem is that investors are not keen on buying rupee securities from the Gift City," a Gift City official said on the condition of anonymity.

Announced in the FY23 Union budget, sovereign green bonds aim to finance public projects focusing on energy transition. In August 2024, the Reserve Bank of India (RBI) allowed eligible foreign investors in Gift City to invest and trade in these bonds. 

Also read | Centre may increase green bond target by 25% to ₹25,000-26,000 crore next year to fund renewable energy projects

However, investors are not keen on buying rupee-denominated sovereign green bonds in Gift City since they are any way free to buy them outside it, official cited above said.

A second person said there are ongoing discussions between the RBI, the IFSC Authority and banks on this issue. Banks have pointed out how foreign investors might not be willing to take the currency risk of rupee bonds, the person said on the condition of anonymity.

Queries emailed sent to RBI and the International Financial Services Centres Authority remained unanswered.

To be sure, while the regulation has been announced, the groundwork for its rollout is still being laid, and investors remain lukewarm.

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The primary issuance of these bonds will be denominated in rupees but the applicant may pay in US dollar or other foreign currency and the conversion shall take place, a second official said. “However, the secondary market trades shall be over-the-counter (OTC) and take place in a foreign currency."

The relatively lower return from green bonds is another dampener.

"There is no greenium, with conventional bond yields rising across the US and Europe, and the imminent change in administration in the US, which spells the near death of the concept of green," said the first person. “All these factors will preclude investors from putting money into a sovereign green bond."

Greenium, or green premium, is the difference between the yield or the return that investors may receive on a green bond and a similar conventional bond. The coupon rate on green bonds tends to quote at a discount to a conventional bond of similar tenure.

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The US 10-year bond yield spiked from 3.7% around mid-September last year when the Federal Reserve began lowering rates to almost 4.7% on concerns that President-elect Donald Trump's planned tariff hikes may boost inflation. The yield on the Indian 10-year paper trades at 6.7%. This implies a spread of 200 bps (a basis point is a hundredth of a percentage point) between the yields. However, considering a hedging cost of 3% per year to protect against a falling rupee, it makes the green trade unviable for a foreign investor seeking higher returns on investment.

“The saleability of rupee green bonds in Gift City currently looks dim, with investors likely to be unwilling to take lower coupon rates associated with such instruments amid rising yields of conventional issuances globally," said Jayesh Mehta, vice-chairman and chief executive of DSP Finance.

Mehta said most such bonds were issued in the US dollar, the pound and the euro, while emerging market issuances were significantly fewer. Indeed, a World Bank report from April 2023 stated that as of January 2023, green bonds of $2.5 trillion were raised globally to support green and sustainable projects. The share of emerging market governments in such issuances was $74 billion or just 3% of the total.

Also read | Govt may raise at least ₹10,000 crore in next phase of sovereign green bonds

Experts said that for investors seeking higher returns, a greenium (or lower coupon amid rising global bond yields), makes little economic sense.

“Post-covid, while the attractiveness of investing in the ESG-theme has picked up, the premium on green bonds has not. This is true for India as well as other parts of the world," said Soumyajit Niyogi, director, core analytical group, India Ratings & Research.

Another bond dealer said that issuing a rupee bond in an offshore jurisdiction like Gift City could also give rise to other offshore markets outside RBI jurisdiction launching rupee-denominated green bonds which are settled in dollars. Such quanto options--which calculate the payable amount in rupees, but pays in equivalent dollars--would defeat RBI's purpose of launching such bonds in rupees in Gift City.

And read | India to hold off on green bonds sale