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Picture Courtesy: Down to Earth

Context:

As India prepares its climate finance roadmap ahead of COP30, the Centre for Social and Economic Progress (CSEP) released a report urging the government to design a Climate Finance Taxonomy Framework that is practical, inclusive, and adaptable, rather than a rigid compliance tool. 

What is taxonomy?

A taxonomy is essentially a system of classification. It organizes things into categories based on shared characteristics or criteria, making it easier to understand, compare, and analyze them.

In different contexts, it can mean:

• Biology – Classification of living organisms (like kingdom, phylum, class, order, family, genus, species).
• Finance/Policy – A framework that classifies economic activities based on certain criteria, such as environmental sustainability or climate alignment. For example, a Climate Finance Taxonomy identifies which activities or investments can be considered “green” or sustainable.
• General Use – Any structured way to categorize information systematically.

Taxonomy = organized system for classifying and understanding things. 

What are Climate finance taxonomy?

Climate Finance Taxonomy is a structured framework that classifies economic activities based on how they contribute to climate goals, such as reducing greenhouse gas emissions or enhancing climate resilience. It essentially tells investors, banks, and regulators which activities can be considered “green” or climate-aligned.

Purpose

• Guide Investments – Helps direct finance toward sustainable projects like renewable energy, electric mobility, or climate-resilient agriculture.
• Standardization – Creates a common language for investors and regulators to assess environmental impact.
• Transparency – Ensures that funds labelled as “green” truly support climate goals, avoiding “greenwashing.”

Key Features

• Sector Classification – Identifies which industries or economic activities qualify as climate-friendly (energy, transport, agriculture, water, buildings, etc.).
• Eligibility Criteria – Specifies thresholds, such as carbon intensity limits or resilience improvements.
• Alignment with National Priorities – Tailored to a country’s development context while maintaining credibility for international investors. 

Why It Matters for India

• India faces a climate finance gap of over $170 billion per year by 2030.
• A robust taxonomy helps unlock investments in both mitigation (emission reduction) and adaptation (resilience-building) activities.
• It ensures inclusion of MSMEs and informal sectors, which form a large part of the Indian economy.

About the Draft:

• Announced in the Union Budget 2024‑25, the taxonomy is a policy tool intended to classify economic activities that align with India’s climate goals.
• It is designed to help direct investment into climate‑friendly technologies and adaptation measures, by giving clear guidance on what counts as “climate‑aligned” in the Indian context.

Key Objectives

• Support mitigation of greenhouse‑gas emissions.
• Strengthen adaptation and resilience of communities and ecosystems.
• Enable the transition of hard‑to‑abate sectors (such as steel, cement, heavy industry) toward a low‑carbon path.
• Prevent greenwashing by clarifying what qualifies as climate‑aligned.

Main Features:

The framework uses a hybrid approach: starting with qualitative criteria (for broad inclusion) and moving gradually toward quantitative benchmarks (emission thresholds, performance metrics).

Activities are classified into at least two broad categories:

• Climate‑supportive: Activities that avoid emissions, reduce intensity, deploy adaptation solutions.
• Climate‑transition: Actions in sectors where immediate low‑emission alternatives are not fully available, but which are on a pathway toward decarbonisation.

The taxonomy also emphasises inclusivity — especially recognising that MSMEs (micro, small & medium enterprises) have different capacities and should be incorporated via staggered criteria.

Sectors Covered:

Initial focus sectors include:

• Power / Energy
• Buildings
• Transport / Mobility
• Agriculture, Food and Water Security (especially for adaptation and resilience)
• Hard‑to‑abate industries like Iron & Steel, Cement

Challenges:

Complexity and Technical Barriers

• Risk of creating a framework that is too technical for investors and businesses to use.
• Complex reporting and data requirements may discourage participation, especially from smaller firms. 

Limited Adaptation Focus

• Global taxonomies often emphasize mitigation (e.g., renewable energy) over adaptation projects like resilient agriculture or urban water systems.
• Capturing adaptation activities is difficult but crucial for India’s climate resilience. 

MSME Inclusion

• Micro, Small, and Medium Enterprises (MSMEs) often lack capacity or resources to meet strict eligibility criteria.
• Without simplified frameworks, many climate-aligned small businesses may miss out on green finance. 

Coordination Across Institutions

• Multiple regulators (RBI, SEBI, Ministry of Finance) must align to avoid conflicting rules.
• Poor coordination can send mixed signals to markets, undermining the taxonomy’s effectiveness. 

Risk of “Transition-Washing”

• Companies might label activities as green without genuine climate benefits.
• Ensuring credibility while remaining practical is a delicate balance. 

Lessons India can learn from global climate finance taxonomy models:

Way Forward:

Practical and Inclusive Framework: Ensure the taxonomy is user-friendly and accessible for all sectors, including MSMEs and informal businesses.

Balance Global Credibility with Domestic Relevance: Align with international standards while reflecting India’s development priorities like job creation, resilience, and inclusion.

Strengthen Adaptation Finance: Include projects that enhance climate resilience, such as sustainable agriculture, urban water management, and coastal protection.

Promote Indigenous Innovation: Encourage homegrown climate technologies while maintaining interoperability for foreign investment.

Dynamic and Evolving Policy: Regularly review and update the taxonomy to reflect changes in science, technology, and market conditions.

Conclusion:

India’s draft Climate Finance Taxonomy is a crucial step toward mobilizing investments for a low-carbon and climate-resilient economy. By providing a structured framework, it aims to guide investors, banks, and policymakers in identifying climate-aligned activities while balancing global credibility with domestic priorities. The draft emphasizes inclusivity, covering MSMEs and adaptation projects alongside traditional mitigation sectors. Its success will depend on clear policy coordination, periodic updates, and practical implementation that reflects India’s development goals and climate commitments. Ultimately, if effectively executed, the taxonomy can become a transformative tool to channel finance toward India’s real climate priorities. 

Source: Down to Earth