Budgeting for the fifth C

• While Covid-, conflict-, central banking- and China-led risks are well discussed, the fifth one, climate change, needs to come into sharp focus now.
  
  
• The last budget conveyed a more serious intent to include the climate agenda in the budgetary process and facilitate green transition.
  
  
• While the government cannot control the physical climate risks to the sector, it can introduce policies that speed up other efficiency improvements.
  

There has been a massive shift in the nature of global risks over the past two years. Broadly, these can be categorised into four Cs — Covid-19-led; conflict-led; central bank action-led; and China slowdown/recovery-led.

A fifth C, which has always been present but started receiving attention only recently, is climate change.

Among the risks mentioned, climate risk remains the only constant, which must be acted upon quickly now.

The Union Budget is a good platform for the government to make its intent loud and clear, on the climate agenda. But budget and climate action are two words rarely spoken in the same breath.

That has changed somewhat in recent years, though, but there is a lot more ground to cover.

The last few budgets had a peppered approach towards combating climate risk. But the last budget conveyed a more serious intent to include the climate agenda in the budgetary process and facilitate green transition in the country. The budget promised action to facilitate, inter alia, wider adoption of solar power, energy conservation and financing via green bonds.

In the Finance Minister’s words, “The risks of climate change are the strongest externalities that affect India and other countries.” There is, therefore, hope that the upcoming budget systematically factors in the two risks often associated with climate change — physical and transition.

Physical risks include the impact of rising sea levels and weather disruptions such as heatwaves, floods, storms and wildfires on economic and financial parameters. These can have severe and sudden consequences, often diverting policymakers’ attention towards mitigating the immediate damage caused by these risks.

India remains one of the most vulnerable countries to climate-change risks, given the exposure to rain-fed agriculture for providing incomes to large sections of the population. High volatility in food prices every year due to weather disruptions has also often challenged monetary policy’s role in controlling inflation.

Climate risk also hurts the fiscal math. For instance, enhancing social-safety nets via subsidies and employment programmes becomes necessary in a year when weather disruptions dent income and purchasing power of the weaker sections of the society. This can put the annual fiscal math off the track or divert spending away from capex.

Climate change is primarily a fiscal challenge for the governments. At the COP27 climate summit in November 2022, India submitted its long-term low-carbon development strategy that aims at expanding renewables use, strengthening energy-efficiency measures, rationalising fossil-fuel resource utilisation and ensuring optimum energy mix, while following on a development-focused transition. The country now needs to move faster towards these targets. Inclusion of the climate agenda in budget-making can help systematise it and support the process.

While the government cannot control the physical climate risks to the sector, it can introduce policies that speed up other efficiency improvements, such as reducing crop wastage, promoting investment in irrigation, and setting up cold-storage and warehousing facilities.

The second type, transition risks are caused by the impact of policy, regulatory and legal actions taken to reduce greenhouse gas emissions and adapt to new technologies, on economic and financial parameters. These include policies that influence trade, push production towards green transition and bring about a shift in consumer preferences.

While these facilitate a move towards an environmentally sustainable economy, in the short run, they come as disruptions and entail a cost. Here, government intervention in the form of budgetary allocations that subsidise and over time penalise failure towards green transition, will be crucial. The climate agenda will require active participation by the private sector.

The long-term trends on rainfall, heatwaves and other extreme events call for immediate action. Meanwhile, the unevenness or lack of predictability of weather conditions highlights the need for the budget to factor in damages and additional costs to counter the impact of weather disruptions.

In the short term, therefore, the Indian government’s climate-action response should also focus on mitigating risks to the agriculture sector, while also continuing to encourage the move towards cleaner technologies.

In addition, given its inflation-targeting mandate, the Monetary Policy Committee of the Reserve Bank of India will also have to take heed of the increasing role of climate change-led weather disturbances in influencing consumer price inflation. As inflation faces upside risks and higher volatility due to climate change, there is a greater need to maintain a credible monetary policy, to keep inflation expectations in check.

Policymakers not only need to work together to reduce the long-term effects of climate change, but also respond to the short-term effects of climate change on the economy.

(The author is Principal Economist, CRISIL Limited. Views are personal.)