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Context

• RBI's decision allows Foreign Institutional Investors (FIIs) like insurance companies, pension funds, and sovereign wealth funds to invest in India's Sovereign Green Bonds (SGrBs).
• These bonds fund projects aimed at speeding up India's shift to a low carbon economy.

Impact on Green Transition:

• Widened Capital Pool: FIIs' investment expands the capital available for India's ambitious climate goals, including achieving 50% energy from non-fossil fuel sources and reducing carbon intensity by 45% by 2070, as pledged at COP26.
• Previous SGrBs Issuance: RBI issued SGrBs worth ₹16,000 crore in 2021, oversubscribed by domestic financial institutions and banks.
• Lower Interest Rates: SGrBs offer lower interest rates compared to conventional G-Secs, leading to a "greenium," incentivizing banks to invest in green projects.
• Encouraging Transition: Central banks and governments globally are promoting green investments to accelerate the transition to a greener future.

Green Taxonomy Gap:

• Definition and Classification: The 2022-23 Union Budget announced SGrBs to fund projects like offshore wind, solar power, and EV transition, but lacked a green taxonomy for assessing environmental credentials.
• Framework Creation: To address this, India released its first SGrB Framework in 2022, detailing eligible projects such as renewable energy, energy efficiency, and EV promotion.
• Validation: Norway-based validator Cicero rated India's framework as "green medium" with a score of "good governance," ensuring credible audit trails and high impact projects are funded.
• Future Prospects: FIIs' interest in diversifying green investments, combined with India's transparent framework, presents an opportunity for significant green investment in the country's projects, contributing to its green transition goals.

Challenges and Opportunities:

• Greenwashing Concerns: There is a need to ensure that investments are genuinely green and not a form of greenwashing, where projects falsely claim environmental benefits.
• Technology and Innovation: Investments in technology and innovation can drive greater efficiency and effectiveness in green projects, enhancing their impact.
• Global Collaboration: Collaborating with other countries and international organizations can facilitate knowledge sharing and best practices in green finance and projects.

Sovereign Green Bonds in India

• Background: In the FY23 fiscal budget, the finance minister announced India's plan to issue sovereign green bonds to finance public sector initiatives aimed at reducing carbon intensity.
• Alignment with Panchamrit: The issuance of India's first sovereign green bonds aligns with the country's five critical climate action elements known as "Panchamrit," as outlined by the Prime Minister during COP26 in 2021. These elements include achieving 500GW non-fossil energy capacity, sourcing 50% of energy from renewable sources, reducing anticipated carbon emissions by one billion tonnes by 2030, decreasing carbon intensity by 45%, and attaining net-zero emissions by 2070.
• LIFE Movement: India launched the LIFE movement at COP26, promoting responsible utilization of natural resources. Green bond issuance reflects India's commitment to environmentally sustainable projects and contributes to the broader goal of maintaining sustainability.

Understanding Green Bonds

• Definition: Green bonds are financial instruments that support environmentally sustainable projects, typically offering lower capital costs than regular bonds. They involve significant fixed-income borrowing by corporations, governments, or institutions to fund green initiatives and promote ecological conservation.

Green Bond Principles

• Guiding Principles: The Green Bond Principles (GBP), regularly updated by the International Capital Market Association, maintain transparency and guide issuers to align with four critical components: green bond framework, use of proceeds, project evaluation and selection process, management of proceeds, and reporting.
• Implementation in India: In January of this year, the Indian government released green bonds adhering to the GBP guidelines. The Sovereign Green Bonds (SGrB) funds will support expenses associated with eligible green projects falling within defined 'Eligible Categories'.

Advantages of SGBs

• Contribution to Sustainability Goals: Indian sovereign green bonds contribute to sustainability goals and strengthen the Indian currency.
• Augmentation of Funds: Issued in local currency within the global market, SGBs attract predominantly domestic investors, augmenting funds within the central bank and reinforcing confidence and trust in the Indian currency.
• Demand for Sustainable Investments: Investors increasingly favor projects contributing to sustainable development, leading to heightened demand for green bonds. Limited supply of green bonds in the market can elevate their price and yield, offering higher yields than traditional debt instruments.
• Boosting Foreign Investment: Green bonds can help boost foreign investment while mitigating currency risk associated with fluctuations in foreign exchange rates by issuing bonds in rupees, reducing exposure to volatility and contributing to the stability of the local currency.

Fig: Eligible Categories under green projects as defined in the SGB framework

Selection of Projects for SGBs

• Green Finance Working Committee (GFWC): The GFWC, established by the Ministry of Finance and chaired by the Chief Economic Advisor, oversees the issuance of sovereign green bonds. Responsibilities include selecting eligible green projects, reviewing allocation within 24 months, addressing postponed or cancelled projects, and supervising the issuance of an annual report.

Fig: Procedure followed in selecting green projects every year by the Government of India

Project Selection Criteria

• Adherence to Green Bond Principles (GBP), SDGs, and National Policies: Criteria for selecting projects adhere to the GBP, United Nations SDGs, and national policies. Ministries collaborate annually to select new green projects, with other ministries invited to provide fresh ideas.
• Budget Division Submission: The budget division of the ministry submits projects approved by the Green Finance Working Committee (GFWC) for bond issuance through the Reserve Bank of India (RBI).
• Sovereign Green Bonds Issuance: Sovereign green bonds, issued by the RBI, finance green initiatives. The Ministry of Finance maintains a green register containing bond details to monitor these bonds.
• Annual Report: The ministry releases an annual report on these projects, detailing bond issuances, approved projects, allocated expenditures, current statuses, and potential impacts on reducing carbon intensity.

Navigating Challenges with Green Bonds

• Insufficient Awareness: Developing economies with emerging green bond markets face challenges due to insufficient awareness about the principles and benefits of green bonds. Investors require a comprehensive understanding of green bond standards to engage effectively.
• Lack of Standardised Selection Procedure: Challenges such as rigorous green bond certification processes pose obstacles for investors, especially in meeting stringent requirements for project verification and environmental standards, particularly in developing nations.
• Limited Credibility of Projects: The absence of specific regulations for green bonds leaves investors unable to assess the financial risk associated with the bonds and understand sustainability for long-term development investments. Distinctions between conventional and green bond regulations raise concerns about the legitimacy and credibility of such projects over time.

The Global Experience with Green Bonds

• The global green bonds market has witnessed substantial growth, reaching $270 billion in 2020 from $36 billion in issuances.
• This growth underscores a global shift towards sustainability, with industries embracing green capital expansion.
• Despite India facing unique challenges, opportunities exist to address these hurdles through various initiatives.

Developing Nations- Emerging Landscape of Green Projects:

• Adoption of Sovereign Green Bonds: Emerging economies like Fiji, Indonesia, Egypt, and Malaysia have adopted sovereign green bonds, inspiring other nations to formulate and implement policies supporting green projects.
• Increased Global Market Share: These strategic transitions have significantly increased these nations’ global green bond market share over the past five years, showcasing their commitment to sustainable development.
• Challenges in Vietnam: Countries like Vietnam still require assistance with legal mechanisms despite their commitments to sustainable development.

Developed Nations- Major Contributors in the Green Bond Market:

• Specialised Efforts in the UK: The UK Green Finance Institute actively promotes green finance through collaborations with governmental bodies, financial institutions, and businesses, advancing the green finance agenda.
• Germany’s Contribution: Germany, facilitated by the KfW development bank, participates in green bond initiatives, financing renewable energy, energy efficiency, and environmental sustainability projects.
• Effective Regulations Needed: Recommendations suggest implementing effective regulations tailored to the green bonds market to ensure sustainability.

The Way Forward for India:

• Enhancing Transparency: Augmenting transparency in green bond issuance and viability is crucial in overcoming existing challenges.
• Conducting Specialised Awareness Programs: Educational programs on green bonds are essential to raise awareness among investors and promote the advantages of investing in green projects.
• Improving Risk Mitigation: Reducing various risks, including legal, default, liquidity, and political risks, requires establishing a favourable environment for private investors.
• Focusing on Domestic Capital Generation: Besides offshore investments, the Indian government should prioritise the establishment of a green capital pool to stimulate domestic demand.
• Issuing Investment Mandates: Integrating green projects into institutional investors’ portfolios could effectively mobilise capital towards sustainable investments.
• Adherence to International Standards: Government-issued Sovereign Green Bonds (SGBs) should adhere to international standards outlined by the United Nations to ensure investor confidence.
• Guidance from RBI: Standardised guidelines for international investors and collaboration between issuers and investors are essential for promoting environmentally friendly investment practices.

Conclusion:

• Government-mandated disclosure standards for sustainability practices are crucial for instilling trust in green bonds.
• By implementing strategies to address challenges associated with green bonds, India can foster a conducive environment for sustainable investments and advance its sustainable progress.

READ ALL ABOUT FPIs: https://www.iasgyan.in/daily-current-affairs/foreign-portfolio-investors-fpis

Foreign Institutional Investors (FIIs)

What is FII?

• Foreign Institutional Investors (FIIs) are entities, typically investors, investment funds, or assets, that invest in a foreign country outside of where they are headquartered or registered.
• In India, the term FII is used for overseas entities that invest in the Indian financial markets.
• FIIs play a significant role in economies, particularly in emerging markets like India.
• They are typically large companies and organizations such as banks, mutual fund houses, and other entities that invest substantial amounts of money in the Indian investment market.
• SEBI is responsible for regulating and supervising foreign institutional investments in the Indian financial markets. The regulation ensures that FIIs adhere to the prescribed rules and guidelines for investing in India.

Types of FIIs:

• FIIs encompass a wide array of institutional investors. In the context of India, the following types of entities are commonly categorised as FIIs:

• Hedge funds
• Sovereign wealth funds
• Foreign mutual funds
• Trusts
• Pension funds
• Asset Management Companies
• University funds and endowments

Role of FIIs in the Economy

• Market Influence: The presence of FIIs in a stock market and the securities they purchase can significantly impact market movements. Their investments can lead to upward movements in stock prices and indices.
• Cash Inflow: FIIs bring substantial cash inflows into the economy through their investments. This influx of foreign capital can help strengthen the local currency and boost economic growth.
• Market Development: FIIs play a crucial role in developing and deepening financial markets. Their participation can enhance market liquidity and efficiency.
• Risk Diversification: FIIs provide an avenue for domestic investors to diversify their investment portfolios by investing in foreign markets.
• Global Integration: FIIs help integrate the domestic market with the global financial system, facilitating cross-border investments and transactions.

The Impact of FIIs on the Indian Stock Markets

Foreign Institutional Investors (FIIs) have a significant influence on the dynamics of the Indian stock markets, playing a crucial role in shaping the country's economy. Here's how FIIs impact the Indian stock markets:

1. Market Volatility:
• FIIs are key drivers of stock market volatility in India.
• Increased FII investments often lead to a rise in the Indian capital market index, while decreased investments can result in a decline.
• This sensitivity to FII flows can cause fluctuations in stock prices and overall market sentiment.
2. Inflow in Market Instruments:
• FIIs bring substantial funds into the Indian stock market.
• This influx has several positive effects:
• It encourages financial innovation as new investment opportunities and instruments are developed.
• FIIs help develop hedging instruments, managing risks and providing stability.
• Their participation can lead to improvements in market efficiency, aligning asset prices with economic fundamentals.
• FIIs contribute to the stability of India's balance of payments by injecting foreign capital into the country.
3. Economic Development:
• FIIs play a crucial role in the development of emerging economies like India.
• Advantages include:
• A healthy inflow of equity capital strengthens the capital structure of Indian companies and bridges investment gaps.
• FIIs promote financial market competition, aligning asset prices with economic fundamentals.
• They contribute to economic development by improving capital markets and promoting financial innovation, spurring economic growth.

Regulatory Measures:

• To limit FII influence and mitigate potential risks, India implements regulatory measures like setting investment ceilings.
• For example, there's a 24% limit on FII investment in the paid-up capital of Indian companies and a 20% limit for public sector banks.
• These limits help control FII influence on financial markets and prevent excessive damage from a massive outflow of foreign investments.

Where can foreign institutional investors invest in India?

Foreign institutional investors (FIIs) have several investment opportunities in India. They can invest in various financial instruments and assets, as outlined in the reference content. Here is an explanation of where FIIs can invest in India:

1. Primary and secondary market securities

• FIIs can invest in primary market securities, such as shares, debentures, or company warrants issued by Indian companies. This involves directly participating in initial public offerings (IPOs) and other new issuances.
• They can also invest in secondary market securities, which include shares and other financial instruments traded on recognised stock exchanges in India.

2. Units of domestic fund house schemes

• FIIs can invest in units of schemes offered by domestic fund houses, including entities like the Unit Trust of India. These units represent participation in various mutual fund schemes.
• These unit schemes can be both listed and unlisted on recognised stock exchanges.

3. Units of collective investment schemes

• FIIs can explore investment opportunities in units of collective investment schemes. These schemes are designed to pool funds from multiple investors and invest them in various assets.

4. Derivatives trading

• FIIs can participate in derivatives trading on recognised stock exchanges in India. Derivatives include financial contracts based on underlying assets like stocks, indices, or commodities.

5. Government securities and commercial papers

• FIIs can invest in Dated Government Securities issued by the Indian government.
• They can also invest in commercial papers issued by Indian establishments, corporations, organisations, or firms, which are short-term debt instruments.

6. Credit enhanced rupee-denominated bonds

• FIIs can consider investing in credit-enhanced bonds denominated in Indian rupees. These bonds are backed by credit enhancements or guarantees to mitigate credit risk.

7. Indian depository receipts (IDRs) and security receipts

• FIIs can invest in Indian depository receipts, which are financial instruments representing ownership in shares of foreign companies that are listed on Indian stock exchanges.
• Security receipts are another option, representing interests in assets converted into marketable securities by financial institutions.

8. Non-convertible bonds (NCBs) in the infrastructure sector:

• FIIs can invest in both listed and unlisted non-convertible bonds or debentures issued by Indian companies operating in the infrastructure sector. The classification of "infrastructure" follows the guidelines for External Commercial Borrowings (ECB).

9. Non-convertible bonds (NCBs) in the NBFC sector:

• FIIs can invest in NCBs or debentures issued by companies belonging to the Non-Banking Financial Companies (NBFC) sector. The Reserve Bank of India categorizes some of these companies as Infrastructure Finance Companies (IFCs).

10. Rupee-denominated bonds by infrastructure debt funds:

• FIIs have the opportunity to invest in rupee-denominated bonds issued by infrastructure debt funds. These funds focus on financing infrastructure projects in India.

FII example

• Imagine a large Canadian pension fund. They decide to invest a substantial amount of money in a group of Indian companies involved in renewable energy projects. These companies are listed on the Indian stock exchange.
• The Canadian pension fund takes a significant stake in these companies, showing their confidence in the future of renewable energy in India. By doing this, they not only potentially benefit from the growth of these Indian companies but also contribute to India's green energy initiatives.
• Now, individual Canadians who are part of this pension fund, from teachers to government workers, indirectly participate in this investment. They might not have the time or expertise to pick Indian stocks themselves, but by being part of the pension fund, they share in the rewards of India's renewable energy boom.
• In India, the role of foreign institutional investors (FIIs) can be as diverse as supporting green initiatives, like in this case, or investing in various sectors to boost the overall financial market. FIIs like this Canadian pension fund help drive investment, contribute to specific industries, and provide opportunities for people far from India to be part of its economic growth.

Role of FII till now

• India's Investment Landscape: India's economy relies on both domestic and foreign investments, which drive its growth and development.
• Foreign Institutional Investors (FIIs): FIIs play a crucial role in India's economy, investing significantly in its equity market alongside domestic investors.
• Positive Trends in FII Investments: Since 1992, FII investments in India have largely remained positive, indicating confidence in the country's market potential.
• Impact on Market Indices: FII investments have led to substantial increases in market indices like the Nifty, indicating their influence on market sentiment and performance.
• FIIs During COVID-19: Despite the challenges of the COVID-19 crisis, FIIs continued to invest in India, contributing to the market's recovery and growth.
• Recent FII Investment Trends: In 2023 and early 2024, FPIs invested significant amounts in India, with investments totaling Rs. 257,155.74 crore (US$ 31.0 billion) by January 29th, 2024.
• Rupee Performance: The Indian rupee has performed well against major global currencies, reflecting the strength of India's economy and market.
• Government Policies: The government has implemented liberalized regulations to attract foreign capital, further enhancing India's position in global markets.
• Overall Impact: FII investments not only contribute to market growth but also indicate global confidence in India's economic potential.

The bottom line

• In conclusion, foreign institutional investors (FIIs) play a pivotal role in the Indian financial markets, providing a crucial link between global capital and India's economic growth.
• This not only benefits these foreign institutions but also opens up opportunities for private investors abroad to access India's growth potential.
• Moreover, the presence of FIIs contributes to market volatility, financial innovation, and overall market efficiency.

FII Vs DII

The difference between FII and DII are:

FIIs	DIIs
The primary distinction between FIIs and DIIs is the investor's location. Foreign institutional investors (FIIs) do not reside in the same country as the investment.	Domestic Institutional Investors (DIIs) are people who live in the same nation as the investment.
FIIS could only invest up to 24% of the entire paid-in capital of the company.	DII ownership is not subject to such restrictions.
FIIs own around 21 per cent of the companies that comprise the Nifty 500.	DIIs, on the other hand, own around 14% of all shares in the Nifty 500 businesses.
Foreign institutional investors (FIIs) invest with a short to medium-term horizon in mind.	Domestic Institutional Investors (DIIs) make long-term investments.

PRACTICE QUESTION Q. Discuss the role of Foreign Institutional Investors (FIIs) in shaping the economy of a country like India. How do FIIs impact various sectors and what regulatory measures are in place to manage their influence? Evaluate the significance of FIIs in the context of economic development and financial stability.

SOURCE: THE HINDU