Managing risks of a green economy

Synopsis: A rapid transition to renewable energy, which is necessary, will disrupt a number of businesses.

Introduction

Climate change will affect lives and livelihoods across the globe with some countries getting disproportionately impacted.

According to a recent report by the Swiss Re Institute, climate change could reduce global gross domestic product by 18% by 2050 if no mitigation action is taken. India would also suffer significantly.

A 2019 International Labour Organization study noted that productivity loss because of heat stress could be equivalent to 80 million full-time jobs globally in 2030.

Clearly, more needs to be done to contain the risk of climate change. However, the other side, that is, discussion on disruptions that a rapid transition to a green economy could entail has not started.

How transition towards clean energy will impact business and government?

Green business risks: A rapid transition to renewable energy, which is necessary, will disrupt a number of businesses. India, for instance, produces the bulk of its power through coal-fired plants and experts argue that it will need to build more such plants to meet its energy requirements in the next few years.

On coal plants: As India moves rapidly towards renewables, capacity utilisation in coal plants would decline, affecting return on investment. This will have implications for both debt and equity holders.

Automotive industry: Similarly, India has a large automotive industry base. As the business moves towards electric vehicles, the market will be disrupted with some legacy manufactures and component makers going out of business. Aside from financial losses, it could also affect employment. Since electric vehicles have fewer moving parts, they need less labour.

Monetary policy and central banking: Recently, former Reserve Bank of India (RBI) governor Urjit Patel argued that not adjusting the central bank reaction functions to climate change will result in suboptimal policy choices. However, as another former RBI governor Raghuram Rajan has argued, they should stay away from such an objective as it is primarily a fiscal issue.

Shifting roles and responsibilities of Central bank towards climate change can affect financial stability, and price stability could also get affected.

Fierce fiscal risks: India’s transition to a green economy will pose serious fiscal risks, both at the central and state level. Both levels of government depend significantly on revenue from petroleum products. Theoretically, if petroleum products are replaced by other sources, this stream of revenue will be wiped out.

If part of the demand shifts to the power sector as incentives for electric vehicles aim, it would create even bigger fiscal complications.

India’s power sector is in problem. The debt of state-run distribution companies is likely to cross the Rs 6 trillion mark in the current year. The state of power distribution companies poses significant risks to state government finances.

Thus, a meaningful demand shift in the automotive sector from petroleum to power can create enormous complications for government finances.

What is the way forward?

First, both the central and state governments will have to reduce dependence on petroleum products for revenue generation. For this to happen, both direct tax and the goods and services tax system will need to be overhauled.

Second, the issues in the power sector will need to be fixed once and for all. It is important to recognise that consumers will have to pay.

If these two issues are not addressed immediately, any meaningful attempt to move towards a green economy would create serious fiscal, growth, and financial stability risks. This could eventually end up increasing climate risks and diminishing India’s global standing.

Source: This post is based on the article “Managing risks of a green economy” published in Business Standard on 23rd September 2021.