Explained: What’s India’s Union Budget got to do with COP26?

What should the union budget 2022-23 tell about India’s climate ambitions announced at COP26? That the announcements are not rhetoric but real. And that the country intends to turn its energy transition ambition into action by aligning the climate and fiscal policies. A climate-responsive budget will set in motion the structural transition of the markets, technologies, and institutions to deliver India’s net-zero commitment at pace and scale. However, accounting for the social and economic impact of decarbonizing existing assets, supporting large-scale capital reallocation, and managing the near-term increase in input costs will matter more than ever in this year’s budget.

The country will have to confront a considerable ramp-up in investments for its low-emission future. Per IEEFA, the country will require $500 billion to reach the 450-gigawatt (GW) renewable energy (RE) capacity target by 2030. According to IEA, India will need $1.4 trillion to finance green energy technologies alone over the next two decades. Raising and deploying finance for the capital-intensive energy transition will remain a persisting challenge for India. And so, the forthcoming budgets will be pivotal in coalescing the policy incentives and fiscal tools to address key investment barriers and accelerate capital inflows in low-emission projects.

India’s power distribution sector is the biggest impediment to clean energy investments. The sector loses $0.005 on every unit of electricity sold. A mix of the high cost of supply, long-term power purchase agreements, and subsidized electricity tariffs has rendered the sector financially unviable. This has resulted in a history of overdue payments to power generators, thus inflating the cost of finance, especially for renewable generation projects. Further, the clean energy plants compete for the same pool of capital as the conventional power assets but stressed thermal plants are putting constraints on market lending. Lowering power procurement costs would need repurposing or retiring India’s increasing stock of stranded, underutilized, or old thermal plants. The transition will likely be complex. The budget could play a catalytic role in structuring incentives and social support for such a phase down.

The second factor influencing the market conditions for the energy transition in India is the nascency of the domestic supply chain of solar photovoltaic (PV) and battery cells. The Indian manufacturers operate at only the last stages of cell and PV value chains. So Chinese imports, 33 percent cheaper than their Indian counterparts, dominate the Indian supply chain. However, the central government’s self-reliance vision has recently prompted import duties on solar modules. Until the domestic manufacturing capacity ramps up, the trade barriers will raise input costs for PV developers, thus materially impacting the return on investments. As a result, the budget should include a time-bound reset of the custom duty.

Lastly, next-generation technologies face challenges in accessing affordable long-term capital. For instance, battery storage faces high capital costs due to underdeveloped manufacturing capacity and limited supply chains. Sovereign guarantees or other risk instruments could enhance the bankability of emerging technologies. In addition, targeted financial incentives could reduce the high upfront cost of upstream activities.

India should prioritize energy transition expenditure in the upcoming union budget and spend at least two percent of GDP towards its net-zero commitment. The budget should provide funding for scaling up public finance for high-risk perception sectors, including green hydrogen, battery storage, fuel cells, skilling and redeployment, and expanding research and market development (R&D). Here are a few expectations from the budget:

Repurposing or retiring old or stressed thermal power plants: Funds should be set aside to explore financial tools such as refinancing or securitization for repurposing or retiring the thermal power plants early. In addition, the funding mechanism should provide for social support programs for affected communities, reskilling, and redeployment of coal workers. The District Mineral Foundation Funds, which remain half unutilized, should be repurposed to manage the social and economic consequences of retiring the power plant.

Incentivizing solar PV manufacturing: The budget should provide a production-linked incentive scheme for PV manufacturing. In addition, incentives such as concessional loans for PV manufacturing should help in de-risking large investments.

Retracting the import duty on PV modules: Until the domestic industry builds the manufacturing capacity to scale up, a time-bound custom duty regime can be put in place.

Incentivizing rooftop solar: A concessional credit line should be extended to micro, small and medium-sized enterprises to install rooftops. In addition, a portion of fossil-fuel subsidy should be used for creating risk instruments to allow access to finance to rural residents.

Incentivizing R&D Investments: The budget should provide for an outlay to invest in R&D. In addition, incentives such as tax credits should be allowed to pull investments into R&D.

Enabling skilling and reskilling of the workforce: Installation of 500 GW of RE may potentially generate 4 million new jobs. Therefore, the budget should provide the funding for supporting the skilling and reskilling of workers for new tasks.

Derisking next-generation technologies: The budget should set aside an outlay for creating multiple risk instruments or credit enhancement facilities for technologies that require higher upfront capital.

India will lead the decarbonization from the front by backing its commitments with detailed plans and resources. Extreme weather events in 2021 alone imposed a cost of $9.5 billion on India’s budget. Unchecked climate change is a choice the country cannot afford.