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Solving India’s Renewable Energy Financing Challenge: Which Federal Policies can be Most Effective?

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Published: March, 2014

Executive Summary

The Government of India has set ambitious targets for renewable energy — a doubling of existing renewable energy capacity to 55,000 MW by 2017. However, unsubsidized renewable energy is still 52-129% more expensive than conventional power, and requires policy support. This policy support is currently provided through a combination of state-level feed-in tariffs and federal subsidies in the form of a generation based incentive, viability gap funding, and accelerated depreciation.

Given the ambitious goals, but limited budgets, the cost-effectiveness of these policies becomes an important criterion for policymakers. In our previous work, we demonstrated that unfavorable debt terms add 24-32% to the cost of renewable energy in India. In this report, we show that if cost-effectiveness were the only criterion of interest, a class of debt-related federal policies that provide low-cost, long-term debt are more cost-effective than the existing federal policies.

However, cost-effectiveness is only one of the many criteria federal policymakers use. In our conversations with policymakers, the following questions emerged as important drivers of federal policy choice: How much of the gap between the unsubsidized cost of renewable energy and the wholesale price of electricity could the federal government cover without state support, i.e. what is the viability gap coverage potential? How much of the budgetary allocation would the government be able to recover over time, i.e. what is the subsidy-recovery potential? How does it ensure that the production of renewable energy is incentivized and not just capacity installation? Given a fixed annual federal budgetary allocation, how much renewable capacity can it support, i.e. what is the one-year budget efficiency?

The eventual decision for the policymaker would depend on a combination of these criteria. In this paper, we provide a framework to compare the existing federal policies for onshore wind and solar photovoltaic (PV) technologies with a proposed class of debt-related federal policies, using project-level cash-flow models. We considered three debt-related subsidies: extend- ed-tenor debt, where the tenor of government debt would exceed commercial debt tenor; reduced cost debt, where the government would provide debt below the commercial rate of interest; and interest subsidy, where the government would subsidize the interest on commercial loans.

The figure on page iv presents a summary of our results for wind energy, assuming that the federal policies are used in combination with state-level feed-in tariffs and that federal support is optimized for cost-effectiveness. The results are similar for solar energy, with slight differences primarily due to the higher capital cost, which results in a larger viability gap. Although there is no single policy that performs better than the others across all criteria, our analysis presents policymakers with crucial tradeoffs that would enable them to choose appropriate federal policies based on relevant policy goals. In particular, there exist combinations of policies that could satisfy multiple policy priorities.

Our main finding is that, in the long-term, debt-related policies are more cost-effective than the existing policies. In particular, the combination of reduced cost, extended-tenor debt is the most cost-effective policy. With a tenor extension of 10 years, for wind energy, a 5.9% loan could reduce the total – i.e., the sum of federal, state, and tax — subsidies by 78% compared to the most cost-effective version of the generation based incentive (i.e., at INR 2.03/kWh). For solar energy, for the same tenor extension, a 1.2% loan could reduce total subsidies by 28% compared to the most cost-effective version of the existing policy, viability gap funding (i.e., at 56%). Furthermore, this policy combination would allow for a high degree of subsidy-recovery — i.e., 76% for wind and 49% for solar.

We also find that reduced cost, extended-tenor debt is more cost-effective than the primary existing policies at current support levels: for wind energy, the generation based incentive of INR 0.5/kWh, with a cap of INR 10 million per MW, to be utilized over 4-10 years; and, for solar energy, the viability gap funding of up to 30% of project cost. For wind energy, we find that an 18-year loan at the commercial rate of interest (i.e., at 12.3%) would reduce the total subsidy by 35%. Similarly, for solar energy, we find that a loan at 6.6% with a tenor increase of 10 years would reduce total subsidies by 18%.

However, reduced-cost, extended-tenor debt may not be the preferred policy in the short-run due to its high capital outlay. For wind energy, compared to this policy, the current generation based incentive can support 83% more deployment in one year, and for solar energy, the current viability gap funding can support 60% more deployment. Thus, although reduced-cost, extend- ed-tenor debt is clearly attractive from a long-term perspective, in the near-term the federal government may have insufficient funds to provide support solely through this policy.

Nevertheless, there are other policy options in the short-term that are more attractive than existing pol- icies at current support levels. For wind energy, for the same state-level support of INR 4.9/kWh, we find that the following policies have advantages over the genera- tion based incentive:

  • An interest subsidy of 3.4% would result in a total subsidy reduction of 11% and would support 83% more deployment in one year.
  • An accelerated depreciation of 38% — i.e., less than the typical 80% — would result in a total subsidy reduction of 17% and would support 87% more deployment in one year. However, accelerated depreciation may not incentivize production as well as the generation based incentive.

Similarly, for solar energy, we find that, compared to a viability gap funding of 30%, for the same state-level support of INR 5.6/kWh, an interest subsidy of 10.2% would result in a total subsidy reduction of 11% and would support 30% more deployment in one year

Based on policymaker feedback, our work can be extended to include appropriate policy design for debt-related policies to ensure alignment with policy objectives. We recommend that the following questions be investigated in more detail: How can federal policies be designed to incentivize production? How could the design of accelerated depreciation be modified to better incentivize independent power producers? How could the government’s cost of lending, including administrative/transaction costs and project risk premium, be better estimated? How should a more comprehensive, long-term measure of capital efficiency be designed? Answering these questions can help India meet its renewable energy goals in the most efficient way possible.