Tag Archives: India

Optimizing Public Payment Support to Enhance the Credit Rating of Renewable Projects in India

June 29, 2018 | , and

 

Investors in Indian renewable energy projects often cite the counterparty risk as one of their primary concerns. Counterparty risk is the risk of purchasers failing to meet their contractual agreement to pay on time – most often in the form of delays in payments, and sometimes by defaulting on the payments altogether. A recent CPI study found that this risk perception can add as much as 1.04% to the cost of debt for renewable energy projects.

A major driver of this risk perception are state-owned utilities’ (called DISCOMs) history of payment delays and defaults. DISCOMS are, by far, the largest off-takers of power in the country, either directly or through government-owned power aggregators, such as the Solar Energy Corporation of India and NTPC Vidyut Vyapar Nigam Limited (NVVN). As a result, power projects, which rely on these incoming cash flows to sustain their operations and interest payments, often find themselves strapped for cash, leading to poor credit ratings by lenders. These delays are the result of the systemic inefficiencies plaguing the Indian utilities sector. While various long-term government reforms targeting this sector are under different stages of implementation, they do not show great promise in curbing the issue of payment defaults in the near term. Government-sponsored risk-mitigation interventions called Payment Support Mechanisms (PSMs) arose from a need to build up the renewable energy power sector in light of this adverse investment environment.

These PSMs are funded pools of capital that provide working capital for projects when the associated off-takers default on their payment obligations. In the past, two such well-intentioned, but opaquely designed, PSM schemes have failed to be successful. Subsequently, tripartite agreements between the central government, state governments, and power aggregators (SECI and NVVN) have acted as powerful deterrents for DISCOMs against payment defaults to the aggregators. However, the counterparty risk in the case of direct procurement still persisted.

A recent technical paper by CPI provides a methodical framework for sizing a PSM with the explicit objective of enhancing the credit ratings of projects under the scheme. This empirical approach employs stochastic modeling of default events under various scenarios to arrive at differing probabilities of a project defaulting, in both the presence and absence of a PSM. Further, unlike a one-size-fits-all approach used by previous PSM constructs, this methodology takes into consideration the differing credit profiles of the DISCOMs gleaned using empirical financial reporting data.

The study provides interesting results, including that by providing a payment support large enough, the credit ratings of renewable energy projects can be enhanced to as much as a BB rating. Further, projects involving DISCOMs, such as in Gujarat and West Bengal, off-takers can achieve a BB rating even in the absence of any payment support. On average, the study finds that most DISCOMs require payment support equivalent to 8-17 months of payment, on average 12 months’ payment.

A concentrated effort from various government bodies has the potential to ensure a positive investment climate and assure that investors will receive payments owed to them at a moderate cost to the exchequer. This will reduce the cost and increase the availability of capital, thereby catalyzing the renewable energy sector. Further refinements towards employing public finance efficiently using empirical evidence is the way ahead to achieve the developmental objectives using available public resources.

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A version of this blog first appeared on Green Growth Knowledge Platform (GGKP), a global network of international organizations and experts that identifies and addresses major knowledge gaps in green growth theory and practice. 

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Mobilizing Institutional Investment in Indian Renewables

June 12, 2018 | and

 

India has been a sweet spot for renewable energy investment exhibiting an 11% compound annual growth rate (CAGR) between 2004 and 2017, and ranked among the top five renewable investment destinations in the FS-UNEP Report. Some major contributing factors have been India’s strong macroeconomic fundamentals, its large and well-diversified renewable market, and India’s ability to offer higher excess returns than several comparable markets like China and the United States.

Excess returns on renewable investments

Mobilizing investments by institutional investors, foreign and domestic, is a requisite for India to meet its clean energy targets.

However, this momentum needs to be accelerated to achieve its ambitious clean energy targets, which include 175 gigawatt (GW) of installed renewable energy by 2022, 40% of the total installed capacity to be renewable by 2030 and 30% of vehicles to be electric by 2030.

One promising opportunity lies in institutional investment, both foreign and domestic, through pension funds, insurance companies, and sovereign wealth funds. These investors mostly seek yield-generating investments in low-risk and long-duration assets which align well with the investment profile of renewable energy. Also, over the course of time, the needs of foreign investors have evolved from seeking small size, high-risk and high-return investments to large size, medium-risk and moderate return investments that are well-matched by the renewable sector offerings.

However, certain sector-specific issues such as off-taker risk, limited availability of listed securities and low credit ratings of renewable energy securities restrict the flow of investments. In order to address these barriers, a recent report by Climate Policy Initiative offers potential solutions to stakeholders, including policymakers and regulators.

Sector-specific barriers and potential solutions

The off-taker risk adds as much as 1.07% of additional risk premium to the cost of debt for renewable energy projects. A long-term solution is to fix the root causes, like the one being tried by the Ujwal DISCOM Assurance Yojana (UDAY). Though UDAY has shown promise in reducing operational inefficiencies and improving financial performance in selected cases, it is still early to measure the effectiveness of the scheme in reducing the off-take risk.

Some other promising short-mid term options include tripartite agreements between the Central government, State governments and the Reserve Bank of India; and a credible payment security mechanism (PSM) either by the corresponding state governments or on a standalone basis. However, both the effected PSM and tripartite agreements are available only for public sector intermediaries – National Thermal Power Corporation (NTPC) and Solar Energy Corporation of India Ltd. (SECI) – between renewable power developers and state DISCOMs. There is need to extend these arrangements to producers who sell power directly to state DISCOMs, which ensures the most judicious use of the public capital employed.

Another key reason for low investment levels from domestic institutional investors in the renewable energy sector is lack of investable securities (listed and liquid) since most developers are borrowing and not issuing securities. Indian policymakers have been aware of the need for these vehicles, and they have been gradually created, both for debt (green bonds and infrastructure debt funds) as well as equity (infrastructure investment trust) financial vehicles. However, green bond issuances (at corporate, not project level), no renewable energy specialized Infrastructure Debt Funds (IDFs), and Infrastructure Investment Trusts (InvITs) are indicators that investors are still trying to get comfortable with these vehicles.

In this context, one potential solution is to incentivize banks and Non-Banking Financial Companies (NBFCs) like Indian Renewable Energy Development Agency (IREDA), to securitize their renewable energy project loan portfolio. The government can cover costs related to securitization of renewable energy loan pools (transaction cost) and subsidize partial guarantee fees on bonds issued through securitization structures.

The third major barrier restricting the flow of investments is limited renewable securities with AA domestic rating – the minimum rating required by institutional investors to invest. Though there is a specific solution, in the form of a partial credit guarantee (PCG) offered by India Infrastructure Finance Company Limited (IIFCL), this is not considered successful yet, with only two renewable energy issuances so far, and those in 2016. One of the key issues with these credit-enhanced bonds is that though these are priced appropriately in the market, the net benefit compared to bank debt does not justify transaction costs. As an example, with PCG, the benefit is a maximum of 1.50%. With cost of PCG at least 0.5% and cost of transaction at least 0.5%, the net benefit of at most 0.5% does not justify the hassle of a bond issuance. Initial subsidization of guarantees and transaction fees may encourage issuers to actively pursue PCG-backed bonds in the renewable energy sector.

Need for regulators to espouse investors to go green

Apart from addressing the aforementioned sector-specific barriers, there is a clear need for insurance regulators to introduce certain guidelines to insurance companies pertaining to climate risk management framework and carbon footprint disclosure. Introductions of such regulations will allow them to actively assess their portfolio exposure to sectors likely to be adversely affected by climate change in the coming year. This will give them a head start to gradually diversify their current investments from such high carbon sectors and ultimately accelerate finances into low carbon infrastructure sectors, including the renewable energy sector.

Another step in the right direction would be to mandate all companies to provide green ratings on their financial securities. These ratings will allow investors who evaluate environmental aspects in their investment decision-making to make more informed decisions around securities. To introduce such a mandate, the government can initially provide incentives to companies or rating agencies to introduce green ratings.

In conclusion, there is an immediate need for policymakers to implement the aforementioned solutions in order to create an investment environment that lowers risk perceptions of investors in the renewable energy sector. These solutions complemented with evolving regulations and the disclosure landscape will be key to scale-up institutional investment in India.

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A version of this blog first appeared on Green Growth Knowledge Platform (GGKP), a global network of international organizations and experts that identifies and addresses major knowledge gaps in green growth theory and practice. 

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Greening institutional investment in India

March 20, 2018 | and

 

India’s energy demand is increasing, and, to achieve its clean energy target of 175 GW by 2022, finance will be crucial.

One promising opportunity lies with foreign and domestic institutional investors who have $70 trillion and $564 billion assets under management, respectively. These investors are bound by their fiduciary duties meant to maximize financial returns to their beneficiaries, without taking excessive risks, while also meeting their liabilities over the long-run. Renewable energy, though a relatively new technology, is well matched to these needs as it offers high returns as well as meets environmental, social and governance (ESG) considerations in their investment strategies.

However, how can India unlock this opportunity to create a clean energy future?

A recent study by Climate Policy Initiative attempts to answer this question by developing a business case for institutional investors to invest in the Indian renewable energy sector, identifying key barriers to investment, and proposing potential pathways forward.

The changing economics of energy in India
According to the report, the renewable sector is becoming increasingly attractive compared with other energy investment opportunities in India. For instance, the solar tariff has actually become 23% cheaper than coal plants, and coal plants exhibit greater risk in cash flows (i.e. 40%) as compared to wind (i.e., 20%) and solar (i.e.,10%).

In the medium term, these changing economics mean that the existing power portfolio of investors, who are mostly exposed to fossil based investments instead of renewable investments, would underperform due to declining demand for fossil based power. Consequently, it is in the interest of institutional investors to gradually rebalance their portfolio in favour of climate friendly investments, in India and elsewhere.

Is India an attractive renewable energy market for institutional investment?
The study builds a case that India as a market is strong and economically attractive for foreign institutional investors compared to other similar markets across the world.

First, it benefits from strong renewable policy commitments as well as a large market size — ~480 GW expected capacity addition over 2016-40 — that is third only to China and the United States. Second, India is ranked 2nd in Ernst & Young’s renewable energy country attractiveness index, based on five pillars including macroeconomic environment, policy enablement, supply–demand dynamics, project delivery, and technology potential. Third, renewable energy in India provides a financially attractive investment, as measured via excess returns,  the difference between the expected return on capital invested and the weighted average cost of capital. India offers higher excess returns of 3.5% compared with other large markets, such as the US (2.4%) and China (1%). While some markets provide higher excess returns than India—for example, Mexico, Canada, and Chile – these are much smaller markets.

So what’s next?
Institutional investors with long-term investment horizons are mostly seeking yield generating investments in low risk and long duration assets, i.e., traits that align well with the current investment profile of renewable energy; this has changed from small size and high risk-high return investments to large size and medium risk-moderate return investments. Although the expected return from renewable energy projects have come down from 20% to 15% over time, this still matches institutional investors’ overall India market portfolio return requirements.

Renewable energy sector stages with risk-return mapping

However, our study finds there are still some barriers to unlocking this apparent match – including, sector specific risks like off-taker risk and limited listed and highly graded investment opportunities, along with currency risk.

The good news is that with appropriate regulatory and policy changes, the sector can provide a high match with institutional investors’ investment objectives.

For example, the central and state agencies could address the off-take risk through a transparent and credible payment security mechanism. Regulators could consider developing incentives to encourage banks and Non-Banking Financial Companies (NBFCs) to securitize their renewable energy loan portfolios, freeing up capital for more renewable energy projects. And investors themselves can consider developing risk management frameworks to assess and manage climate risk, identifying and investing in forward looking investment opportunities, renewable energy being one, to mitigate climate risk in their portfolio.

These steps, and the others we outline in the study, are a win win for all – for India, it’s a way to get much needed capital in a much needed area. For investors, their long-term portfolios depend on it.

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A call for innovative green finance ideas to help India meet its climate goals

November 24, 2016 |

 

Last week, I was in Marrakesh speaking at this year’s UN climate change conference, COP22, where I witnessed an important transition in moving from talk to action. Just a few weeks before the start of COP22, the Paris Agreement officially entered into force – the historic international agreement for action on climate change that emerged from COP21 last year. While COP21 was about promises and commitments, COP22 was about working out the details to put those promises in place.

Under the Paris Agreement, India has pledged that renewable energy will be 40% of the country’s expected electricity generation capacity in 2030, along with a 35% reduction in carbon intensity by 2030 from 2005 levels. In addition, India has also set one of the most ambitious renewable energy targets of all – 175 GW of renewable energy by 2022, including 100 GW of solar power.  These important targets are not only good for the climate, but can also help meet the energy demand of India’s rapidly growing economy and population.

However, a lack of sufficient financing for renewable energy in India may present a formidable barrier to achieving these targets. This was a key item of discussion at COP22.

An upcoming report from Climate Policy Initiative shows that in order to meet the target of 175 GW of renewable energy by 2022, the renewable energy sector in India will require $189 billion in additional private investment, a significant amount. The potential amount of investment in the renewable energy sector in India is $411 billion, which is more than double the amount of investment required. However, in a realistic scenario, the amount of investment expected falls short of the amount required by around 30%, for both debt and equity.

A call for innovative green finance ideas - Potential equity and debt investments

In this context, and as India moves to implement its commitments under the Paris Agreement, the work of the India Innovation Lab for Green Finance is increasingly important. The India Lab is a public-private initiative that identifies, develops, and accelerates innovative finance solutions that are not only a better match with the needs of private investors, but that can also effectively leverage public finance to drive more private investment in renewable energy and green growth.

The India Lab has recently opened its call for ideas for the next wave of cutting-edge finance instruments for the 2016-2017 cycle, in the areas of renewable energy, energy efficiency, and public transport. Interested parties can visit www.climatefinanceideas.org. The deadline to submit an idea is December 23rd.

The India Lab is comprised of 29 public and private Lab Members who help develop and support the Lab instruments, including the Indian Ministry of New and Renewable Energy, the Ministry of Finance, the Indian Renewable Energy Development Agency (IREDA), the Asian Development Bank, the World Bank, and the development agencies of the French, UK, and US governments.

In October 2016, the India Lab launched its inaugural three innovative green finance instruments, after a year of stress-testing and development under the 2015-2016 cycle. They will now move forward for piloting in India with the support of the Lab Members. The three instruments include a rooftop solar financing facility, a peer-to-peer lending platform for green investments, and a currency exchange hedging instrument. Together, they could mobilize private investment of more than USD $2 billion to India’s renewable energy targets.

Now that the Paris Agreement has been ratified and the real work begins, the India Innovation Lab for Green Finance can help India transition from talk to action by driving needed private investment to its renewable energy targets. Visit www.climatefinanceideas.org to learn more and submit your innovative green finance idea by December 23rd.

A version of this first appeared in the Huffington Post.

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Four ways to jumpstart rooftop solar power in India

September 15, 2016 |

 

The Indian government has rightly made rooftop solar power one of its top clean energy priorities – here’s how they can jumpstart the nascent market.

With a bold goal of delivering 100 GW of solar power by 2022 India is helping to create one of the world’s fastest growing solar markets. Impressive strides have been made towards building out the 60 GW of utility-scale solar power necessary to make good on the goal. However, the remaining 40 GW of rooftop solar power needs a boost. Getting this market right can help put a serious dent in the energy poverty suffered by 80 million households currently lacking electricity, and is critical for supporting the country’s growing middle class.

Rooftop solar power has enormous potential in India and has experienced steady growth in recent years. It offers electricity consumers a lower electricity bill (on average 30% savings for businesses and 18% for industry), and a reliable alternative to intermittent electricity from the grid. The problem is, while the market is growing at a “blistering 300% pace”, even more is needed to get from approximately 1 GW today to 40 GW in 2022. A new report from Climate Policy Initiative (CPI) shows a few ways we can unleash even greater growth.

India's rooftop solar power - Solar power generation forecast

Support Third Party Financing

A third party financing model consists of a rooftop solar developer, a third party financier, and a consumer. The developer installs a rooftop solar plant on a consumer’s property and the third party financier invests in the project. The consumer agrees to purchase electricity at a specified price for 15 to 25 years, with no upfront cost except their monthly electricity bill. The third party financing model removes the burden of high upfront installation costs for the consumer, as well as perceived performance risk, or the perception that the technology may not perform as expected over its lifetime.

The third party financing model has been a significant driver of growth in the rooftop solar industry globally, especially in the US where up to 72% of rooftop solar installations in 2014 were third party-owned. The model has also started picking up recently in other countries, including China and Japan.

But in India it only supports 13% of rooftop solar installations under operation or construction. The industry believes that there is potential to increase the total installed capacity under the third party financing model to more than 20 GW by 2022, meaning that it could unlock more than half of the government’s 40 GW target.

The third party financing model is also a good opportunity for investors. With government incentives, all states in India offer internal rates of return (IRR) of at least 14% and as high as 42% for rooftop solar projects financed by third parties. And, as the cost of solar falls, more sectors in Indian states are becoming profitable without these incentives. Over 40% of the opportunities  already offer IRRs of 14%-34% even without government incentives.

Train Banks to Help Unlock Local Debt

It’s no secret the solar business is capital intensive. That means access to debt finance is critical to its long term success. Since the rooftop solar sector is new and transaction costs are high (due to the smaller size of projects), bankers don’t yet feel comfortable lending to projects. The most significant challenge to the third party financing model today is low access to debt finance.

To increase access to debt for rooftop solar power, the Ministry of New and Renewable Energy (MNRE) can work with development banks to provide a system of trainings to bankers in India to increase their understanding and comfort with rooftop solar loans. Trainings can include how to assess rooftop solar projects, how to process solar loans, and the dynamics of the rooftop solar industry and associated risks.

Given the depth and breadth of the local banking system, and the $625 million it now has to solve this problem thanks to the World Bank, high leverage interventions like these can get the money flowing.

Get DISCOMs in the Game

Another important step is addressing consumer credit risk. Consumer credit risk is the second biggest challenge to the third party financing model. Low availability of credit assessment procedures, low enforceability of agreements, and lengthy and costly legal processes in the case of a dispute or payment default all conspire to hold back investment.

One way to reduce consumer credit risk is for MNRE and state governments to include India’s state-level public electricity distribution companies (DISCOMs) as a party to the power purchase agreement between the developer and the consumer. While DISCOM balance sheets don’t exactly inspire confidence, they do have the power to terminate grid supply which can provide an effective ‘stick’ to ensure customer payment.

DISCOMs are also responsible for implementing net metering, which is a policy that has been passed in nearly all states that makes rooftop solar power more viable by enabling consumers to use solar power generated during the day at night. However, at present, there is little incentive for DISCOMs to prioritize net metering implementation which means most rooftop solar companies don’t take advantage of it. One way to overcome DISCOMs’ reluctance would be to incentivize them to fulfill their Renewable Purchase Obligation (RPO) requirement – a government requirement to install solar power – via rooftop solar installations, by providing 30% more credit to rooftop solar power generation compared to utility-scale solar power.

Invest in Financial Innovation

Last but not least it’s clear that financial innovation has been key to unlocking clean energy abroad, and it is likely to be useful inside India as well. The India Innovation Lab for Green Finance, a public-private initiative, administered by CPI and modeled after the successful Global Innovation Lab for Climate Finance, is currently developing several instruments which have the potential to drive significant investment into third party financing for rooftop solar power.

The first, Loans4SME, is a peer-to-peer lending platform that connects investors directly with borrowers and could help improve access to debt financing for the rooftop solar industry. The second, the Rooftop Solar Sector Private Financing Facility backed by the IFC, could increase access to debt financing for the rooftop solar industry by creating a warehouse structure that aggregates and purchases large numbers of small projects helping to inject liquidity into the market. This also enables an aggregate deal size large enough and of sufficient credit quality to attract more attention from investors, especially institutional investors.

Taken together, these policy and financial solutions can jumpstart India’s rooftop solar industry and put it on track to achieve the government’s target of 40 GW of rooftop solar power by 2022, a goal the whole world should get behind.

This post was co-authored by Gireesh Shrimali of CPI and Justin Guay of the David and Lucile Packard Foundation. A version of it first appeared in Greentech Media and also in The Huffington Post.  

 

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Two policy improvements to drive more renewable energy deployment through mini-grids in Uttar Pradesh, India

April 26, 2016 | and

 

This post is co-authored by Stephen Comello, Associate Director of the Sustainable Energy Initiative at Stanford Graduate School of Business and a Research Fellow at the Steyer-Taylor Center for Energy Policy and Finance.

With about 80 million households across rural India lacking access to electricity, the country’s policymakers have been searching for solutions to close this development gap. At the same time, the public-sector electricity distribution companies (DISCOMs) are unable to systematically extend the central grid to where it is needed.

Off-grid alternatives include kerosene lanterns and small, individual home solar systems. However, another alternative, called mini-grids, offers what these lanterns and small solar systems cannot ­­– the promise of at-scale, off-grid electrification with productive capacity; that is, the ability to simultaneously power multiple loads such as lighting, tools, appliances and machinery.

A mini-grid is a group of interconnected loads and distributed energy resources that acts as a single entity. On a per unit basis, mini-grids offer electricity at least 50% lower life-cycle cost than diesel generators, kerosene lanterns and individual home systems. Moreover, mini-grid development could spur entrepreneurship and local business opportunities in the energy sector.

Enabling mini-grid development by the private sector is mainly the purview of the State Energy Boards (SEBs) across India. While the central government has developed national mini-grid guidance, clear policy that creates the mini-grid market must originate with the state governments. Formation of such a policy is a delicate balance, as there are multiple significant barriers to mini-grid development, such as financing, revenue collection and system maintenance. Most of these hurdles can be overcome with well-formed business models, supported by effective policies.

Uttar Pradesh (UP), which has some of the lowest electricity access rates in the country, has recently announced a promising first-of-its-kind new policy promoting mini-grids, which could set the benchmark for other states to follow.

Mini-grids in Uttar Pradesh Photo credit: Flickr user sandeepachetan

The policy offers developers flexibility with respect to the general business model to be pursued through the choice of two models. Model 1 offers a 30% capital subsidy, in exchange for the DISCOM regulating project location, mini-grid technical specification, the service level, and, customer-wise tariff rates. Model 2 is arguably the diametric opposite; no subsidy offered, with the developer free to choose location, technology service level and rate charged. Given the flexibility, there has been great interest in Model 2, with 85% of applications made under this scheme.

The policy also provides guidance with respect to the key risk for mini-grids – the threat of central grid extension. There have been multiple instances where the central grid eventually extended to a mini-grid and forced the operator out because entrepreneurs couldn’t compete with DISCOMs’ highly subsidized rates. This situation is known as a hold-up problem, where a developer is deterred from making any investment, given the lack of safeguards to provide the confidence of earning an appropriate return.

The UP policy specifies that if or when the central grid extends to the mini-grid, mini-grid electricity would be purchased by the DISCOM at “the tariff decided by UP Electricity Regulatory Commission or a tariff decided on mutual consent”, and “based on the cost-benefit analysis of the installed project, the project will be transferred to the DISCOM at the cost determined on mutual consent between DISCOM and developer by the estimation of cost (or profit loss) of the project installed by the developer.”

Unfortunately, the UP policy does not fully address the hold-up problem, primarily because of the ambiguity faced by the developer in terms of securing his investment at the time of central grid extension. Specifically, the prospect of the stated “cost-benefit analysis of the installed project”, provides no guidance or methodology necessary for a developer to understand the expected value of the mini-grid in the event of grid extension before the initial investment is made. This raises concerns about the effectiveness of the policy in deploying mini-grid capacity.

Thankfully, based on a recent study at Stanford Graduate School of Business, this policy gap can be closed with two amendments which ensure that the entrepreneur would be indifferent between the event of grid extension and continuing as an independent operator.

First, the entrepreneur should have the unilateral right to transfer ownership of all distribution and generation assets of the mini-grid to the DISCOM.

Second, the transaction price must be given by the current book value of these assets. The book value must be calculated so as to reflect economic fundamentals, based on the concept of replacement cost accounting. What this means is that if revenues are set so as to cover all operating costs, depreciation and a fair return, the developer will be indifferent between receiving a one-time buyout of the mini-grid equal to current book value, or continuing to operate the mini-grid.

Taken together, these amendments would significantly improve UP’s mini-grid policy, leading to UP maximizing mini-grid investment and, therefore, deployment. The success of UP’s mini-grid policy would send a positive signal to other states, and enable them to help India move towards its off-grid deployment targets of 3 GW.

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Two instruments for attracting foreign investment to renewable energy in India

March 17, 2016 |

 

As India prepares to meet its increasing energy demands, which will likely double by 2030, the government has set a path towards ambitious renewable energy targets of 175GW by 2022, and likely 350GW by 2030. These targets are good for the Indian economy, the climate, and the 400 million Indian citizens who currently lack access to electricity.

Raising enough finance will be an essential piece of achieving these targets. Currently, it’s estimated that reaching the 2022 targets would require USD $160 billion.

Domestically, India faces a shortage of available capital for renewable energy projects. The Indian government has stated several times, most recently at the Paris climate talks, that, in order to meet these targets, a significant portion of funding will need to come from foreign sources.

At the same time, the governments of developed countries are willing to provide some of this capital, but would also like to leverage their public-sector spending, by attracting private investment to renewable energy. Indeed, greatly scaling up investment from the private sector will be essential to mobilize the full amount of capital needed to meet India’s renewable energy targets.

However, private foreign investment in renewable energy projects in India faces two key barriers: currency risk and off-taker risk.

To address both of these major risks, there are potential short-to-mid-term solutions that can both drive private foreign investment and leverage public finance from Indian and foreign development institutions and governments.

Renewable energy in India - Outside of Jaisalmer, Rajasthan.

Photo credit: Flickr user Daniel Bachhuber

A Currency Hedging Facility to mitigate currency risk

Because currency exchange rates can be volatile, when a renewable energy project is financed by foreign capital, it requires a currency hedge to protect against the risk of currency devaluation; otherwise, foreign investors risk losing their gains due to depreciations in the Indian currency. However, longer-term currency hedges (beyond three to five years) are not easily available in the Indian market. In addition, market-based hedging in India is expensive (for example, 7% or higher for a ten year hedge), ultimately making foreign financing just as expensive as domestic financing.

One solution to currency risk could be currency hedging sponsored by the Indian government. Recent analysis by Climate Policy Initiative shows that a government-sponsored currency hedging facility, if designed appropriately, could not only provide long-term hedges (ten years) but also reduce the hedging costs by up to 50%. To do so, this standby facility, in order to reach India’s sovereign credit rating, would need to be approximately 30% of the hedged capital.

A Payment Security Mechanism to mitigate off-taker risk

The second major barrier to foreign investment is off-taker risk. In India, the major off-takers are the public sector electricity distribution companies (DISCOMs), which are in a precarious financial situation. Because of the financial state of DISCOMs, investors are concerned that the DISCOMs might default, jeopardizing their investment.

One solution to mitigate off-taker risk could be a payment security mechanism which would cover payments to investors in case of potential defaults. This would significantly reduce the perception of default risk and encourage foreign investment, thereby improving the availability of foreign capital. Climate Policy Initiative’s analysis shows that payment security mechanisms would need to be approximately 7% of capital expenditure to cover defaults over one year.

How the Indian government can help

The Indian government is in the best position to manage both currency and off-taker risks. For currency risk, macroeconomic conditions are key drivers of currency movements, and government policy can influence macroeconomic conditions. For off-taker risk, the DISCOMs are public-sector entities, essentially supported by the government.

Therefore, the Indian government and public finance should play a significant role. The Indian government can use some of its own money to fund the currency hedging facility as well as the payment security mechanism – for example, from the National Clean Energy Fund, or from the expenditure budget.

How international governments and development institutions can help

The international community can pitch in by not only supporting technical assistance but also contributing funds to these facilities. For the currency hedging facility, there may also be gains from diversification by creating the facility for multiple currencies, given that currency movements will likely offset each other.

The international community can also help by creating political will around this process of creating these facilities. This would require key engagement from government stakeholders from both developed countries and developing countries, in addition to development finance institutions like the World Bank, Asian Development Bank and the Asian Infrastructure Investment Bank.

As we move forward with the historic climate agreement that emerged from COP21 in Paris, there has never been a better or more important time to develop and implement the solutions that can drive the required finance to India’s renewable energy targets.

The Indian government, governments of other nations, development finance institutions, and private investors all have key roles to play in moving these targets from dreams to reality.

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Instruments of Change: Raising Investments for India’s Climate Commitments

December 18, 2015 |

 

The international climate agreement that emerged from the Paris negotiations this past weekend marks a historical turning point for the whole world, but particularly for India.

As a part of the global climate deal, national governments have shared plans for their countries’ action on climate change, and India’s contribution is ambitious — promising that renewable energy will be 40% of the country’s expected electricity generation capacity in 2030, along with a 35% reduction in carbon intensity by 2030 from 2005 levels.

India has also set one of the most ambitious renewable energy targets of all ¬- 100GW of solar power by 2022. This is more than half of the amount of solar power deployed worldwide at the end of 2014, and more than 20 times India’s current solar deployment. Additionally, India has also set a wind power target of 60GW by 2022, up from 25GW currently.

At the same time, Prime Minister Modi’s administration is likely to significantly increase the production of domestic coal. This is because one of the nation’s top priorities is to rapidly deploy energy in order to meet the needs of its growing economy and to provide electricity to the 400 million Indians who currently lack it.

Recognising the harmful air pollution and greenhouse gas emissions that an increase in coal production will bring, Prime Minister Modi stated during the Paris negotiations a willingness to further move away from coal if there were more finances available for renewable energy.

However, India faces two key challenges around funding for renewable energy and other green infrastructure: a shortage of available financing, and financing at unattractive terms — such as high cost of debt, short tenor and variable interest rates — which can add up to 30% to the cost of renewable energy in India, compared to the US or EU.

 

Public-private collaboration will be essential to raising the finance needed for India’s cleaner growth. While the right domestic policies will be key to facilitating finance, greatly scaling up investment from the private sector will be the only way to mobilise the full amount of capital needed to meet India’s renewable energy targets.

In order to scale up private investment, India needs financial instruments for renewable energy and other green infrastructure that are a better match with investors’ needs.

For example, one source of investment that has great potential but requires innovative finance instruments to facilitate it is foreign investment. Over the next five years, India expects over $160 billion of investment from international developers and banks to finance renewable energy projects. However, foreign investors are wary of investing in infrastructure in India due to the risk of extreme and unexpected currency devaluation.

Because currency exchange rates can be volatile, when a renewable energy project is financed by a foreign loan, it requires a currency hedge to protect against the risk of currency devaluation. Currently, market-based currency hedging in India is too expensive, making foreign financing just as expensive as domestic financing. An innovative instrument that can reduce the currency hedging cost could mobilise more foreign capital and spur investment in renewable energy.

A new public-private initiative in India, the India Innovation Lab for Green Finance, aims to identify, develop, and accelerate these innovative solutions to drive more investment for green growth in India.

The India Lab brings together experts (from the government, financial institutions, renewable energy, and infrastructure development) to select and help launch this next wave of cutting-edge finance instruments. Since its launch on 12 November, the India Lab has received the endorsement of the Ministry of New and Renewable Energy, and was supported in a joint announcement on energy and climate by Prime Minister Modi and UK Prime Minister David Cameron, during Prime Minister Modi’s visit to the UK in November.

The India Lab is currently seeking ideas for innovative finance instruments for renewable energy (including utility scale, distributed, and off-grid), energy efficiency, urbanisation, and other channels for green growth that can overcome barriers and risks and scale up more capital from new investors. Interested parties can visit www.greenfinancelab.in/ideas to learn more.

The new global climate agreement represents a moment of opportunity, for both India and the rest of the world, to capture the momentum and excitement that has come with the hope for a more climate-resilient future, and channel it into real work and real action.

There has never been a better, or more important, time to scale up finance for renewable energy projects and other green infrastructure that can support cleaner economic growth in India.

The India Innovation Lab for Green Finance can help India achieve its vision for a cleaner and more prosperous future by driving needed private investment to its green infrastructure targets. Let’s get to work — now.

A version of this first appeared in the Huffington Post.

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Three ways to attract domestic institutional investment for renewable energy projects in India

September 10, 2015 |

 

Institutional Investment

In order to achieve India’s renewable energy targets of 175 GW of solar and wind power by 2022, approximately USD 100 billion of investment in renewable energy infrastructure will be required, including USD 70 billion of debt.

While these ambitious renewable energy targets are important and admirable, financing them is going to be no easy task. Renewable energy in India has traditionally relied on domestic commercial banks for financing; however, this bank financing has become constrained by several limitations. Many banks are nearing their exposure limits to the power sector, and existing regulations do not distinguish between lending to fossil fuel-based power and renewable energy. In addition, the typical tenor of bank loans is around ten years, whereas most renewable energy projects require longer-term financing that matches the project life cycle of 20 to 25 years. Finally, bank debt at 12-13% interest rate is also costly; and together these inferior terms of debt – the high cost, short tenor, and variable interest rates – make renewable energy in India approximately 30% more expensive than in the US or the EU.

Achieving India’s renewable energy targets is going to require mobilizing a lot more debt at more attractive terms, from alternative sources.

One promising solution is domestic institutional investors, such as insurance companies and pension funds, who are ideally positioned to both increase availability of debt and provide debt at more attractive terms to renewable energy projects. Compared to commercial banks, institutional investors not only invest over longer terms, but also accept lower returns in exchange for lower risks, thus providing a better match with the risk-return profiles of renewable energy projects.

Preliminary analysis by CPI, performed earlier this year, shows that these institutional investors are likely to invest approximately USD 400 billion from 2014 to 2019. Based on their traditional share of 3.75% of their investments going to the power sector, if this share could be diverted to renewable energy, that would provide USD 15 billion of debt financing – a significant amount of the debt required to meet the targets.

So, what’s the catch? First, given high risks during construction, institutional investors, who prefer low risk, are unlikely to invest in renewable projects before they start operation. Second, even for operational projects, institutional investors require a domestic debt rating of AA or higher, which most renewable energy projects do not have.

The first issue is manageable – domestic banks can continue to fund projects under construction, and institutional investors can help refinance operational projects. This would free up bank debt to be used for new projects.

As to the second issue – enabling institutional investment will require financial instruments that can raise the credit rating of renewable energy projects. There are two promising instruments that may be able to do this: infrastructure debt funds by non-banking financing companies (IDF-NBFCs) and renewable energy project bonds with partial credit guarantees (PCGs).

IDF-NBFCs are pooled investment vehicles designed to facilitate investment across infrastructure sectors, including renewable energy. PCGs are a form of credit enhancement where the borrower’s debt obligations are guaranteed by a guarantor with a strong credit rating.

Both of these instruments can reduce risks to meet institutional investors’ minimum requirement of an AA rating. Compared to commercial loans, they have the potential to provide provide more attractive terms of debt by lowering the cost of debt by up to three percentage points, and increasing the tenor by up to five years.

However, both instruments face structural and regulatory issues which have impeded their use as investment vehicles. We identified three of the key issues that, if addressed with the right policy changes, could enable institutional investment in renewable energy.

First, for both instruments, the domestic debt market does not differentiate between construction and refinanced loans, making it hard for banks to release debt for refinancing. This can be addressed by encouraging public banking institutions to provide loans during the construction state of renewable energy projects, in order to catalyze the construction debt market.

Second, IDF-NBFCs require a three-way agreement between the project developer, the project authority (usually state-owned power distribution companies called DISCOMs), and the IDF-NBFC. However, in India, the poor financial health of DISCOMs presents a risk. The government can mitigate this risk by creating a model agreement for IDF-NBFCs which includes government guarantees for off-taker risk and robust termination provisions.

Third, for renewable energy bonds with PCGs, existing regulations limit institutional investors to investing in only up to 10% of the bond offering. This would require more than ten institutional investors per bond offering, which is difficult given associated transaction costs and the small number of institutional investors in India. Relaxing this regulation so that investors could subscribe to 25-33% of the bond offering would help address this barrier, making it possible to raise the required debt from only three to four institutional investors.

By taking these three steps, the government of India may be able to make significant progress towards financing India’s renewable energy targets, by harnessing the potential of institutional investment into renewable energy.

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India Needs to Fix Finances to Make Renewable Energy Dreams a Reality

February 16, 2015 |

 

Over the past few years, the government of India has set ambitious targets for wind and solar energy: current targets would see wind and solar capacity grow by 600 percent through 2022, to 60 GW and 100 GW of energy, respectively, from current cumulative installed capacity of about 25 GW. To put those numbers in perspective, 1 GW provides power for 700,000 modern homes; 160 GW would power a sizeable portion of India’s energy needs.

These targets are good for both India’s energy supply and for economic growth – a theme emphasised by US President Barack Obama and Indian Prime Minister Narendra Modi recently in announcing their joint commitment to increasing investment in clean energy and low-carbon economic growth.

However, this task is made difficult by the government’s limited budget, which is constrained by a large fiscal deficit and multiple development priorities.

Further, markets will not provide finance to meet these targets alone. In fact, our analysis shows that the single biggest challenge to scaling up renewable energy is the cost of finance – in particular to debt. Unfavourable debt terms add 24-32 percent to the cost of renewable energy in India, compared to similar projects in the US. Domestic debt is expensive due to unfavourable macroeconomic conditions as well as underdeveloped capital markets, and foreign debt becomes expensive once hedging costs are added.

The good news is that India can address this situation in a way that also saves money for taxpayers, electricity customers, and scales up renewable energy.

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