India’s climate future is a policy choice

PM Modi during Independence Day 2021

Prime Minister Narendra Modi announced that India would achieve carbon net-zero emissions by 2070. This is easier said than done, and for some good reasons. 

 First, India has many years of economic growth ahead of itself. Before the pandemic India had a GDP/capita (PPP adjusted) of ~$7k far lower than China at $16k, Japan at $42k and the US at $65k. Given that the last few decades of economic growth have led to large increases in carbon emissions (India emitted 2.63 billion tonnes of CO2 in 2019 versus 1.6 billion in 2009), it is likely that future years of growth too will also lead to a similar increase in emissions. 

Second, despite the deceivingly low carbon emissions per capita number, India’s power sector has among the highest emissions intensity (source here: page 54)  among large economies. Should manufacturing be the driver of Indian growth, (as the government wants it to be), it would mean that energy demand grows faster than before. Which also means that Indian emissions increase faster than before, and faster than what one would expect from the service and agriculture based economy of the previous decades. 

Third, energy generation isn’t everything! While ensuring that energy is generated from low carbon sources is one large step to reducing carbon emissions, the government still has to deal with a power distribution that is not financially equipped to distribute renewable power (or with sufficient losses, any power!), increased urbanisation and higher demand for consumer durables that emit a large amount of greenhouse gases like ACs and refrigerators. 

It might be tempting to not care. After all, haven’t rich countries emitted the majority of the carbon dioxide in the air now? Isn’t it their responsibility to worry about this, and shouldn’t developing countries like India focus on becoming rich first and worry about rich country concerns like carbon emissions later? Not exactly. 

First it is unfair to put the entire blame on developed countries. Developed countries have made substantial progress on reducing their carbon emissions. The 3 largest developed countries (US, Japan, Germany) have had declining emissions for many years now. The US hit its emissions peak in 2007, Japan in 2012, and Germany in 1990. They have higher shares of renewable energy than most large developing countries like India and China and have a lower carbon intensity of GDP. 

Second, avoiding the extreme cases of climate change is worth a lot for every single country, regardless of its development level. If for example, global CO2 concentrations exceed 600 parts per million, there is a non-negligible chance that global temperatures might increase by 5℃. Martin Weitzman estimated it at 29%, and for higher CO2 concentrations, it would be even higher. India will be severely affected by such extreme outcomes. For example, even with current policies, the Climate Impact Explorer expects that the high end of river damages in 2050 is nearly 3x today, as it is for river flood depth. The worst case scenarios for climate change imply that crop yields drop 30-40% in India. Indian agricultural yields are already very low, and this would hurt millions of small farmers who are already facing financial stress. The key point is that as temperatures increase, the uncertainty in what happens increases. We might be able to mitigate the effects at lower levels, but should it go to higher temperatures, the negative effects do not have a clear limit. It should be a clear priority for all countries to avoid large increases in CO2 emissions that lead to the worst effects of climate change. 

Finally, should the Indian economy grow and India become a larger geopolitical player than it is today, other countries will ask India to pay its share in cutting carbon emissions. Work for that has to start as soon as possible.  

There are a few major challenges that the Indian government will have to deal with in the coming decades.

Coal’s Black Spot

People think they know how much of a problem coal is. I assure you, that almost nobody’s intuition matches how bad coal is for the people. One terawatt hour of coal leads to 1.5x the deaths of oil, 5 times the deaths from biomass, 8 times the deaths from natural gas,  350 times the deaths from nuclear, 650 times  the deaths from wind and 1200 times the deaths from solar and hydropower! (Source here). 

Coal makes up 44% of India’s energy supply but 70% of energy emissions. The International Institute for Sustainable Development estimates that in 2018 the social cost of coal in India was around 4 trillion rupees (about 54 billion USD).  It is not surprising that researchers have calculated that it causes roughly 112,000 deaths a year and building current plants would cause 844,000 deaths. 

Coal’s influence is going down in India albeit from a very high level. Solar is finally cheaper than coal, and there are several stranded coal assets in India. Along with that, the Indian government has committed to reducing coal to 50% of electricity from 70% today. 

But then, why does coal continue to dominate in India? The first answer is that it is cheap, abundant (with caveats) and reliable. Nearly 56% of Indian energy capacity (44% of supply and 70% of electricity) is from coal. Among the 3 largest energy sources, coal is the only one which has abundant domestic supplies. 75% of oil is imported compared to 50% of natural gas and only around a third of coal. Along with its low cost, there are several political economy reasons why coal isn’t going to go away quickly in India. 

First, the Indian government earns a large amount of money from mining coal. It is a majority owner in Coal India, the country’s largest coal miner with 85% of the coal supply. Nearly 25% of the Indian government's dividend revenue from state owned enterprises comes from Coal India. Reducing coal mining would have a noticeable impact on the Indian government’s finances. Along with that nearly 5% of India’s tax revenues come from coal mining, and there are a large number of levies and taxes on coal amounting to over 85% of the base price of coal. 

While coal is not a large percentage of India’s economy, coal mining is a large percentage of specific states in India. For the Indian states of Jharkhand and Chattisgarh, coal mining forms 10% and 9% respectively of their states’ economy. Any actions to remove coal would not only be politically costly in these states but also would be met with opposition from them, because of job losses and tax revenue losses. Indian states are dependent on the central government for general revenue whose negotiations are a contentious process every 5 years. So, revenue independent of New Delhi is valued by them. (Watch the CM of Punjab here at 0:55 talk about it for a brief second followed by Chhattisgarh CM later in Hindi)

The paradox regarding taxation of coal is that governments have two incentives: maximizing revenue and minimizing the social cost of pollution. The social cost of carbon in India is estimated to be around $86 per tonne of CO2. No government would tax carbon emissions of $86, but the real point is that there is a tension between maximizing tax revenue and correcting the cost of pollution. The socially optimal tax on carbon to compensate for the human cost of pollution is far higher than the tax optimal to maximize revenue. When given a choice, policymakers will pick the latter. They just can’t afford to lose the revenue from it. 

Another way coal feeds into the Indian economy is via cross subsidizing passenger railway fares. Coal is the largest component of the Indian Railways revenue, forming 44% of its revenue. India has the lowest passenger fare to freight fare value of any country in the world of 0.24. This is because the Railways overcharges coal by around 30%, and uses this to compensate for the loss it makes on passenger rail. This also raises Indian electricity costs by around Rs. 0.21/kWh. 

It is clear that coal has to go faster than ever. But the problem is that it is deeply intertwined with the Indian government, and they will be reluctant to let it go. Any government decision that is politically feasible and that intends to stick through election cycles has to ensure that it deals with the tax problems of, and that of the railways’ financial health. 

Solar’s Bright Future

India’s solar capacity has been increasing at a rapid pace. From just 161 MW in 2010, it has increased to 34,000 MW in 2020. This is still short of the government’s target goal of 175,000 MW in 2022 but still a very large improvement from ten years ago. There are a few reasons why this has worked, according to interviews with industrialists. (Source here - chapter 5). 

The first reason is reverse auctions. In a regular auction for any good, people submit goods and bid the price up. In a reverse auction people bid downwards, typically for the right to provide a service. This helps avoid corruption and increases confidence that the market is fair. India’s reverse auctions for solar have been a success. They have attracted large experienced foreign companies, have had competitive bidding and low prices. An auction in November 2020 sold the right to provide 1 GW of electricity, and that too for the lowest price in recent history. 

Second, the government’s usage of solar parks has helped investors get financing and gain legibility in their projects.  For a project in a solar park, a developer can answer questions by banks and investors much better, and this makes it worth it despite the slightly higher cost. 

These two have led to large increases in Indian solar capacity. That being said, there are still several challenges the industry faces, primarily driven by policy uncertainty from both state and central governments. 

First, state governments need to honor the contracts at the prices and terms set at reverse auctions. Solar prices have dropped over the years in India reflecting increasing investor interest and supply. As a result of this, state governments that had auctioned off electricity capacity in earlier years are now worse off because their competitor states are getting lower prices, while they are locked in with higher prices. State governments can complain, grumble and publicly lament their bad luck. Nobody gets hurt from that. 

But what crosses the line is them cancelling already signed contracts because they can get lower prices elsewhere! Four state governments have done this in various forms. First it was Andhra Pradesh, cancelling previous Power Purchase Agreements despite the protests and warnings of the central government. Then it was Punjab renegotiating the price it got after the contract was signed. The Gujarat government cancelled a Letter of Intent and Uttar Pradesh cancelled a tender despite the price for it being set. These actions are damaging not only to the Indian governments’ reputation with international investors, but also the general climate for the rule of law in India. They have already led to foreign investors pulling out of India, and several gigawatts of solar contracts have already been cancelled. The correct policy solution for this is not obvious outside of state governments deciding to honor them, but the slow speed of the court process means that they can get away with it. 

Second, there is the problem of import tariffs. Around 80% of solar panels used in India are imported from abroad - mainly China. The Indian government wants to reduce this and the urge to do so only went up after last May’s clashes. So, they have imposed two policies to reduce this. The first is a local content regulation - a rule that all government contracts to supply solar energy have to have locally made panels. Research shows that these requirements led to 6% higher energy costs. The other more important policy is import tariffs. The government has imposed a 40% duty on panel imports with the intent of increasing domestic production. Indian solar panels are on average 33% more expensive than imported panels. While this had the intent of increasing production of solar power and developing domestic capacity, that didn’t happen. First it takes years to develop solar manufacturing and in the meantime between now and then, it is only going to increase solar energy prices hampering the transition. Second, foreign companies producing in India would not buy from Indian producers even if they have lower costs right away. They typically have a list of suppliers they trust and it will take time for Indian companies to enter this. The solar tariffs only make it more difficult for them to develop in India and depress their returns, with no increase in demand for domestic production. 

Most importantly, the barrier for domestic solar production according to interviews with developers is not that Indian costs are too high. It is that to develop economies of scale and invest in large quantities that drive down costs, Indian developers need demand certainty and integrating backwards the value chain. India’s low GDP growth before the pandemic led to slowing energy demand and state governments reneging on their contracts only made it worse. The long gestation period of such manufacturing facilities means that companies have to be absolutely certain of demand for their products.

Finally, if the government insists on having domestic capacity for national security reasons, it is far better for them to subsidize production of domestic capacity across the supply chain to build high quality products that will match the standards of foreign suppliers than to tax imports. There are examples of this with the Modified Special Incentive Package Scheme and Production Linked Incentive. 

The future is a policy choice

There is a lot more to be said by the government on this. First, urbanization in India is going to increase over the coming decades. While the government has decided to consider sustainability in city planning in the New Urban Agenda forum, they have not stated any clear plans for mitigating the emissions impact of consumer good spending like ACs and refrigerators. Along with that, any government that wants to take bold policy moves regarding accelerating renewables will face strong political opposition. 

I am however, very much optimistic on India’s climate future. The reason for it is that unlike almost any other major economy, the majority of India’s climate future is yet to be decided. That means that there is still hope, and good public policy can change it.