Climate change: Is only agriculture sector at risk?

By Mahua Acharya & Labanya Prakash Jena

Last month, the Reserve Bank of India (RBI) released its annual report. Tucked into the 326-page document was something new: Several references to the increasing vulnerability of India’s economy to climate change, with a particular focus on our agricultural sector.

It’s good news that RBI is raising and leading on this issue. India’s economy was already in a downturn when Covid-19 hit. And if Covid-19 made waves, climate change will make tidal waves. In fact, up to 4.5% of the economy is at risk annually as the climate worsens, and India is ranked as the fifth most vulnerable in the world.

RBI focused on agriculture as the main at-risk sector, but, in fact, it is only one of the many areas of concern. Other sectors are also obviously affected by the same phenomenon: Housing, transportation, forestry, fisheries and tourism due to storm and flood, and construction, manufacturing and hospitality due to rising heat and humidity, are also at risk. For example, economic losses to Kerala due to the 2018 flood were approximately $ 4.1 billion, of which the economic loss to transportation and housing was about $1.4 billion and $0.4 billion, respectively.

In its report, RBI noted that central banks and regulators need to provide leadership in these areas, including through “the propagation of Environment, Social and Governance (ESG) principles through the standardisation of the ESG investment terminology, design of a standard disclosures format for firms, and by incorporating ESG principles in financial stability assessments.” This is a great step.

Additionally, central banks around the world are taking initiatives that include not only climate risk management, but also monetary and financial stability policies that support mobilisation of green investment. The Network for Greening the Financial System, formed by central banks, now has 69 members, and 13 observers have embarked on the task of integrating climate change risks in the financial system.

While India, undoubtedly, has ambitious targets for clean energy—and climate change is rightly embedded into economic development—to do more through markets, the Indian financial system at large needs to back a green trend, including green recovery from Covid-19. In a previous report, RBI had acknowledged that climate change risks could adversely affect the stability of the financial system—a common understanding amongst financial regulators across the globe.

The latest work by the Climate Policy Initiative shows that India is only mobilising about a tenth of the investment needed to meet our climate goals. While this is a conservative estimate due to lack of data stemming from the absence of a robust budget tagging system, we do know that we are generally still falling short of the potential, despite the commercial viability of most green technologies.

The starting point for changing this is nomenclature. And RBI agrees that ‘greenwashing’ or false claims of environmental compliance, and plurality of green loan definitions, are the two key challenges to green finance. An agreed upon formal definition of green finance in India could deliver multiple benefits. It could enable more precise tracking of finance flows to green sectors, which, in turn, could help design effective policy, regulations and institutional mechanisms directed towards increasing both public and private investments in green sectors.

A formal definition could also accelerate the development of green financial products and services for investors and depositors, enabling financial intermediaries to assess their climate change risks and opportunities, and improve reporting and disclosure practices.

While some international region-specific initiatives like the EU’s green taxonomy or China’s green bond catalogue and green credit policy have already shown promise for scaling up green projects, there are a number of additional international initiatives focused on defining green. However, India’s financial sector is not fully in step with any organised domestic or international initiative that focus on aligning definitions, disclosure and reporting practices. A green finance definition in India could be formed through a combination of adopting international practices, developing a set of principles for green economic activities, and obtaining stakeholder views.

While a market-led collaborative can accelerate green capital flows, beginning with an agreed upon definition, scaling up green finance in India also requires policy actions and regulatory interventions.

So, what’s standing in the way?
The playing field could become uneven. While identifying climate risk is important, first-mover companies would face the risk of being lumped with all the costs of measuring their climate risk and possibly higher cost of capital, only to, possibly, end up being punished for their transparency, if other companies kept quiet. A host of related questions subsequently arise: What happens if these risks were disclosed? How would analysts rate their shares? What would the investment perception be? If the risks were then mitigated, where would that capital come from? So, while the concept is simple, the repercussions are complex.

There’s also a risk to the financial system. If it turns out that banks and NBFCs, insurers, pension funds, and mutual funds aren’t properly pricing in the risks posed by climate change to their financial assets, the value of these assets could erode suddenly. But, by how much? And who determines it?

Recognising and disclosing climate risk is a logical step generally, and the repercussions are uneven unless all entities are required to disclose. The operative word, therefore, is ‘all’.

Acharya is Asia director and Jena is manager, Climate Policy Initiative