Budget 2022: Enabling funding for green growth and innovation

Budget 2022: Enabling funding for green growth and innovation

Regulatory challenges and operational bottlenecks have precluded deep foreign penetration and, therefore, the share of foreign banks in the banking system’s total assets stands at less than 10 percent. The budget provides a great opportunity to address this issue. In line with the global practice of corporate tax parity, the differential between the corporate tax levied on branches of foreign banks and domestic banks should be reduced to ensure parity. All BRICS countries, except India, as well as majority of Organisation for Economic Co-operation and Development (OECD) nations treat local and foreign entities as equal. This will encourage foreign entities to consolidate and even expand their operations in India, enabling a greater influx of global commercial capital. This move should be supplemented with efforts to encourage foreign banks to invest in green sectors using the priority sector lending mechanism. The RBI guidelines on priority sector lending aims to encourage credit penetration to certain credit deficient areas, including agriculture, renewables, SMSEs and has recently expanded its ambit to include start-ups as well. Perhaps, in a classic quid pro quo, the priority sector lending limits for the foreign banks should be increased beyond the current threshold. Further, the limits should allocate a quota for green investments. As an example, a certain percentage should be reserved for clean-tech companies in the overall start-up lending bracket. This will give an impetus to innovation and invention of scalable green technologies, which hold the tremendous potential to expedite our efforts in combating climate change.

1. Reduce corporate tax for foreign banks  In time, this pressure will hopefully translate into actual actions from global investors. However, we must also focus on creating the right domestic conditions to actually absorb these investments. The present fiscal and taxation structure does not provide the right signals to direct investment to the green sectors. Further actions are also needed to address some of the long-term impacts of the green transition, such as the evolving dynamics of green supply chains. This year’s budget provides a good opportunity to take concrete steps towards creating an enabling ecosystem to accelerate green finance. In this piece, we highlight three such areas where some action will be desirable.

Foreign banks located in India are well placed to act as an effective conduit to global commercial capital, which can be leveraged for investments in green sectors. However, foreign banks in India pay a significantly higher tax than their domestic counterparts.  Branches of foreign banks are taxed at the base rate of 40 percent (plus surcharge and cess) as opposed to domestic banks which have a lower rate option at 22 percent (plus surcharge and cess) under the current tax laws. The differential serves RBI’s objective of encouraging foreign banks to set up wholly-owned subsidiaries in the country. However, regulatory challenges and operational bottlenecks have precluded deep foreign penetration and, therefore, the share of foreign banks in the banking system’s total assets stands at less than 10 percent. Currently, there are only 46 foreign banks in India, which collectively operate around 300 branches. The present fiscal and taxation structure does not provide the right signals to direct investment to the green sectors.

The budget provides an opportune moment for the government to prepare the ground for a national carbon tax, directly linked to the intensity of carbon emissions in fuels. A paper by Shakti Sustainable Energy Foundation and EY, clearly delineates the significance and urgency of imposing a carbon tax to limit carbon emissions while augmenting fiscal revenues, which are currently heavily dependent of fossil fuels, and therefore, preclude a stringent policy shift towards renewables. Such a tax can also improve the tax-GDP ratio and generate additional funds, which can be utilised for offsetting the burden of the tax on low-income groups and facilitate greater investments in green and environmental projects. As an example, Japan uses carbon tax revenues to promote renewable energy and low carbon and energy efficient technologies, whereas Ireland transfers the total revenues to the general budget to allow greater flexibility in labour taxes. Denmark, on the other hand, uses a hybrid distribution model, where the revenues are used both to subsidise energy efficient investments and reduce taxes on labour. While there is a plethora of fiscal and regulatory instruments deployed to reduce carbon emissions, they have been largely ineffective in mitigating at scale. Therefore, the budget provides an opportune moment for the government to prepare the ground for a national carbon tax, directly linked to the intensity of carbon emissions in fuels. This will send the right price signals to producers, investors, and consumers to shift towards cleaner sources of energy.

A carbon tax sets a price on carbon by defining an explicit tax rate on the carbon content of fossil fuels. It is considered an effective way to reduce carbon emissions, and over 27 national jurisdictions and eight subnational jurisdictions have successfully implemented a carbon tax; however, it continues to remain a contentious subject in India given its political un-popularity, and as it involves a very complex and tedious tax system.  2. Adjust the taxation system to incorporate a representative carbon tax

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