Inflation, as a term, has become a part of our day-to-day life; in fact, it is nearly impossible to discuss GDP growth without addressing inflation. Isabel Schnabel, a member of the European Central Bank (ECB), introduced the terms ‘climateflation,’, ‘fossilflation’, and ‘greenflation’ to describe how climate change, fossil fuels, and the energy transition can potentially lead to inflation or inflationary pressures. Greenflation refers to the impact that environmental policies and legislation may have on the cost of delivering goods and services.

Green inflation highlights the demand-supply gap for environmentally friendly products and services. For example, an electric vehicle (EV) is significantly more expensive to acquire compared to an internal combustion engine vehicle. This cost difference can be attributed to “green inflation.” 

The impact of green inflation can affect individuals or entire ecosystems, depending on the underlying factors driving green inflation for a product or set of products and services. For example, renewable energy generation creates two potential revenue streams: the sale of electricity and additional income from the sale of “carbon credits” and/or “renewable energy certificates (RECs)”. The value of these credits or certificates is influenced by domestic or international regulations, which, in turn, have cascading effects on the broader ecosystem.

This principle also applies to international policies like the EU’s Carbon Border Adjustment Mechanism (CBAM), designed to ensure emission parity between goods produced within the EU and those imported from non-EU countries. The entire value chain of goods across multiple geographies is affected. For instance, steel suppliers outside EU member states (not covered by the EU Emissions Trading System) will face a choice: either reduce margins to cover the cost of compensatory emissions reductions via CBAM or invest in upstream technologies to lower greenhouse gas emissions at production facilities.

Conversely, in the case of electric vehicle purchases, buyers may benefit from state subsidies that offset the impact of green inflation by reducing upfront costs. It is equally important to note that subsidy is not perpetual in the latter case, while in earlier case, the requirement of subsidy could be for a significant period.

Developing nations like India are deeply committed to minimizing the impacts of climate change while ensuring sustained economic growth. The philosophy of “minimum government, maximum governance” has played a pivotal role in advancing energy efficiency initiatives, such as the Perform-Achieve-Trade (PAT) scheme, which has been implemented successfully with limited “green inflation” for designated consumers. Similarly, the Extended Producer Responsibility (EPR) framework introduced by the Central Pollution Control Board (CPCB) holds the potential for delivering long-term environmental benefits with minimal “green inflation.”

A paradigm shift is underway as evolving ESG performance expectations drive businesses to commit to change. However, like other forms of inflation, green inflation—when applied across sectors—is likely to trigger a redistribution of wealth from lenders to borrowers. Investments made as part of this green transition should not be evaluated using the “10-10-10 rule”, which considers the consequences of a decision over 10 minutes, 10 months, and 10 years. Instead, it is crucial to contain green inflation, so it contributes to a “redefined quality standard” rather than becoming “self-mutating,” thereby fulfilling its promise of fostering sustainable economic growth. The next time you buy a product and agree to pay a premium reflecting green inflation, take a moment to understand the concept of “product stewardship” as a responsible buyer.