The government of India announced in its recent 2015-2016 Budget that it has set a target of 100GW of solar power by 2022, thirty times the existing capacity of approximately 3GW, and five times the previous target of 20GW under the 12th Five Year Plan.

Reaching this target is not going to be an easy task. Currently, the government is facing large deficits and competing budget priorities, so a cost-effective path is crucial.

Climate Policy Initiative and the Indian School of Business recently examined the costs and different policy pathways to achieving both the wind and solar power targets, in our latest report: Reaching India’s Renewable Targets Cost-Effectively. We found three key lessons for lowering the cost of achieving India’s solar power target.

First, we found that imported coal is the fossil fuel that the additional solar power would likely replace, and that a fair assessment of costs should compare the cost of electricity from renewable energy with the cost of electricity from imported coal.

A fair comparison is key to determining the cost of achieving India’s solar power target. Imported coal is the likely fossil fuel because domestic coal and natural gas are both limited in supply, and because imported coal currently accounts for 18 per cent of India’s total power generation, higher than India’s target of 15 per cent of generation from renewable energy by 2020.

Second, through our analysis, we found that solar power will be competitive with imported coal by 2019. The cost of installing solar power will continue to decrease, as developers become more efficient with experience. Meanwhile, fossil fuels will become increasingly more expensive, primarily due to inflation and increased transportation costs.

Currently, the cost of electricity from solar power is 11.79 per cent higher than from imported coal, and will require some government support from 2015 to 2019. In order to achieve a target of 20 GW of solar power by 2022, the total cost of government support would be Rs 46.97 billion, or Rs 2.71/W, under the current federal policy of accelerated depreciation.

Third, we looked at more cost-effective policy pathways, and found that government support could be significantly reduced by 96 per cent by replacing the current federal policy with reduced cost, extended tenor debt. Under reduced cost, extended tenor debt, the government would make direct loans to project developers below the commercial rate of interest for longer than the usual commercial tenor. The cost of support would fall by 96 per cent to Rs 1.81 billion, or Rs 0.1/W.

This is because, under reduced cost, extended tenor debt, the net cash outflow for the government is recovered over time since policy support is provided in the form of a loan rather than a grant. It also provides an opportunity for interest arbitrage in cases where the government lends at a higher rate of interest to the developer than its own cost of borrowing (7.8 per cent on a 10-year government bond), the net cash flows for the government are positive. Project economics are still improved as long as government rates are more attractive than current market debt rates. Lastly, when debt is cheaper, the developer can substitute equity with more debt in the project while meeting debt servicing conditions. By replacing expensive equity with cheaper debt, the overall cost of capital is reduced.

India has ambitious targets for renewable energy; however, with a limited budget, it’s important that the government take the most cost-effective policy path. Adjusting current policy to more effectively deploy solar power would help lower costs. To accelerate solar power sooner to meet the Budget 2015 goal of 100 GW, revised upwards from 20GW, the government would need to provide more financial support.

We also found that wind power is already cheaper than power from imported coal, and will remain competitive beyond 2022. The government should encourage rapid deployment of wind power through policy measures that address non-cost related barriers to wind power, for example challenges in land acquisition and delays in environmental clearances.

To read our full report, visit https://climatepolicyinitiative.org/publication/reaching-indias-renewable-energy-targets-cost-effectively/.

A version of this blog first appeared in Businessworld.