Saon Ray and Vasundhara Thakur
As the exigency of addressing climate change challenges grows, many countries are looking to reduce emissions and transition to net zero. At COP26 in Glasgow, India announced that it will achieve net zero emissions by 2070. This raises two key questions: What are the likely pathways for achieving this target and how will these pathways be financed? Here, we focus on the latter question, which concerns the financial system.
To improve the reach of the financial system, countries embark upon initiatives aimed at enhancing financial inclusion. As the net of the financial system widens and its coverage improves owing to these initiatives, increasing numbers of individuals are brought under its ambit. This provides the financial system with additional resources. At this juncture, where these financial resources are diverted matters. One of the uses of these funds can be in assisting the movement to net zero, underscoring the linkage between financial inclusion and emissions.
Examining the linkage between financial inclusion and emissions is extremely significant for India, since it has embraced several initiatives to enhance financial inclusion in the past couple of years. Many of these initiatives are geared towards bolstering banking access. In terms of the banking sector, enhanced financial inclusion can translate into more credit advances, as well as more deposits. Besides this direct potential increase in the banks’ deposits and credit advances, some portion of the increased deposits may also be advanced by banks as loans. Further, the increase in deposits can also mean additional income for the deposit account holders, from the interest received. The impact on emissions as a result of this increased fund availability is contingent significantly on the emission intensity of the activity to which the funds from all of these channels are directed, at the level of all the economic actors involved.
Our work leverages the ARDL bounds testing procedure to examine the linkage between financial inclusion and carbon emissions in India. We use two financial inclusion measures, bank branches per capita and credit account per capita. The indicators have been selected with our focus on the banking sector in mind. Through our empirical exercise, we find a long-run relationship between financial inclusion and carbon emissions. In the Indian case, financial inclusion positively influences carbon emissions in the long run. Moving beyond, we also assess whether the interaction of financial inclusion and financial development influences carbon emissions. We find no statistically significant impact of the interplay of financial inclusion and financial development on carbon emissions in India in the long run.
At the bank level, this positive relationship may indicate reluctance in advancing finance for green uses owing to the presence of unknowns. These findings highlight the need for India to make a simultaneous effort in directing the flow of finance resulting from the widened financial net towards greener purposes. This can help identify and mitigate barriers facing financial institutions, particularly banks, in financing low-carbon activities.
In light of India’s COP26 announcement, these findings assume significance, particularly with respect to the financing of the likely pathways that India may adopt to achieve its net zero target. Further, if India wants this transition to be a ‘just’ one, directing finance to pertinent uses becomes even more crucial. Another key suggestion within this discussion pertains to financial literacy. India has adopted initiatives such as the establishment of the National Centre for Financial Education and the launch of the National Strategy for Financial Education 2020-2025 to enhance financial literacy. To support India’s transition to net zero, financial literacy can be thought of as a tool for not just imparting knowledge regarding the available sources of finance and how to best leverage them, but also to spread awareness on channelling funds into green avenues.