In the first part of our series on “Transforming India’s Climate Finance Landscape through Sector-Specific Financial Institutions,” we explored the critical role of institutions like the Power Finance Corporation (PFC) and REC Limited in facilitating India’s transition to a sustainable energy future. This second part will explore these institutions’ potential financing opportunities and transition risks.

As per Landscape of Green Finance in India by CPI, India will require a substantial INR 162.5 trillion (USD 2.5 trillion) by 2030 to meet its Nationally Determined Contributions (CPI, 2022). However, despite a gradual increase, tracked green finance flows still cover only about a third of this requirement (CPI, 2024). On a longer horizon, despite India’s ambitious net-zero pledge by 2070, a significant USD 10 trillion (nearly thrice its current gross domestic product) funding gap exists (ET, 2024).

Bridging this shortfall presents challenges and opportunities, particularly for financial institutions like PFC and REC, which can expand their roles, especially in financing green and transition technologies or initiatives that decarbonize the power sector and other hard-to-abate industries.

Financing opportunities

As per Landscape of Green Finance in India by CPI, understanding opportunities for green financing involves scoping the investment needs, especially in the infrastructure space. Infrastructure development is a key driver of India’s economic growth, with a substantial appetite for investment. The National Infrastructure Pipeline (NIP), which focuses on sectors such as energy, roads, airports, ports, and railways, is projected to drive approximately 70% of the INR 111 trillion (USD 1.5 trillion) capital expenditure (DEA, 2020). The energy sector, specifically renewables and supporting infrastructure, will continue to be an area of interest. This is aligned with one of the key objectives under the Central Electricity Authority’s (CEA) National Electricity Plan — doubling the country’s power generation capacity by 2032. With 87% of this capacity expected to be from non-fossil fuels, an estimated investment of INR 31 trillion (USD 356 billion)will be required (CEA, 2023).

Further, it is essential to understand the avenues for investment in the hard-to-abate sectors. In this context, transition finance, which refers to financing projects that are not entirely green but are progressing toward reducing emissions, is becoming increasingly relevant. Hard-to-abate industries like steel and cement manufacturing face significant challenges in emission reduction. These challenges include high capital expenditures, the long lifespan of existing high-emission assets, and the lack of technological maturity and high costs of newer net-zero technologies, which make these net-zero technologies commercially unattractive. However, there are mature, commercially viable technological solutions that can help reduce emissions significantly but not reduce them to near zero. As these technological solutions cannot be classified as green, their access to capital is often limited. Here, transition finance can help alleviate the burden of these challenges for currently high-emitting sectors.

In addition to potentially benefiting specific heavy industries, transition finance projects can allow power-focused institutions to diversify their portfolios and address transition risk.

In a bid for better financial resilience and responsiveness, PFC is already diversifying its portfolio in the infrastructure sector. It has committed to lending up to 30% of its outstanding loan book to non-power infrastructure projects. In FY23 alone, PFC sanctioned INR 167 billion (USD 2 billion) for various non-power infrastructure initiatives. For instance, it extended a loan of INR 6.3 billion (USD 73 million) to Blu Smart to finance 5,000 passenger electric vehicles (PFC, 2024).

REC is equally committed to diversifying into the infrastructure sector. The institution has established an annual lending cap for non-power infrastructure projects and aims to increase its clean energy portfolio to 30% of its loan book by March 2030 (REC, 2024). In FY 2022-23, REC sanctioned INR 857.4 billion (USD 10 billion) for large-scale infrastructure projects and secured debt funding for renewable energy initiatives, including INR 60.8 billion (USD 700 million) for 1,440 MW of pumped storage power projects with Greenko. Additionally, REC actively supports government schemes within the power distribution sector by providing counterpart funding and project sanctions.

Navigating challenges and transition risk

Building on the momentum of diversification, PFC and REC can strengthen financial resilience by navigating challenges such as stranded asset risks, high costs of thermal plant flexibilization, emerging alternative technologies, and shifting energy demand.

The risk of stranded assets is a significant concern. As renewable energy costs continue to fall, fossil fuel assets risk becoming commercially uncompetitive. The pace of this change is particularly fast as solar tariffs have nearly halved from INR 4.63 per kWh (USD0.05 per kWh) in 2015 to approximately INR 2.36 per kWh (USD0.03per kWh) recently (IEEFA, 2020). With cheaper renewable power available, distribution companies might renegotiate or abandon power purchase agreements linked to fossil-fuel assets, further straining PFC and REC’s financial strategies.

Regulatory policies mandating the flexibilization of thermal power plants to facilitate renewable energy integration also impose a substantial capital burden for renovation and modernization. The CEA mandates that coal-based thermal power plants ramp up 1%-2% per minute, likely increasing to 3% shortly (CEA, 2022) (CEA, 2023). Additionally, the current technical minimum load requirement for thermal power plants is around 55% of their rated capacity, with an expected lowering to 40% to enhance grid stability as renewable penetration grows (CEA, 2023). The capital requirement for retrofits ranges from about INR 60-70 million (USD 0.69-0.80 million) for relatively newer units to about INR 300 million (USD 4 million) for very old units that have not upgraded their plant control and instrumentation system (Powerline, 2023). Compliance can be particularly challenging for older units, often termed vintage thermal power plants, due to technical limitations and cost considerations, leaving them vulnerable to mothballing or decommissioning, consequently impacting financial returns for stakeholders like PFC and REC.

Technological advancements in energy storage further heighten risks. Battery storage prices have dropped dramatically, from over USD 1,100 per kWh in 2010 to around USD 139 per kWh in 2023 (PV magazine, 2023). This reduction enhances renewable energy’s viability, enabling greater integration and reducing the reliance on fossil-based power generation. As storage solutions become more widespread and affordable, the demand for traditional thermal power may diminish, leading to further revenue uncertainties for the financing institutions tied to legacy assets.

Moreover, shifting energy demand patterns and integrating distributed energy resources presents another set of challenges. Government initiatives promoting rooftop solar and decentralized energy solutions, supported by subsidies and favorable net metering policies, are reshaping consumer behavior. These trends disrupt the traditional centralized power generation model, necessitating strategic pivots by PFC and REC to finance adaptable and distributed solutions to remain competitive.

Creating a supportive environment

A supportive policy and regulatory environment are vital to successfully navigating challenges and capitalizing on opportunities. India has made significant strides in creating a conducive landscape for climate-focused finance through initiatives such as the National Action Plan on Climate Change (NAPCC) and the Green Energy Corridor project. However, enhancements can further foster adequate financing focused on fighting climate change.

Developing a comprehensive green finance taxonomy will provide consistent guidelines for identifying and classifying green investments, ensuring that projects contributing to climate change mitigation have access to funds. Strengthening incentives for such investments, such as tax breaks for financial institutions prioritizing green projects, can accelerate capital flows into target areas. Additionally, regulatory support to transition PFC and REC into ‘Climate-Focused FIs’ could be highly beneficial. This transformation could enable the institutions to offer a broader range of innovative financing solutions tailored to low-carbon projects. Encouraging public-private partnerships can also significantly impact the availability of finance, leveraging private capital for large-scale renewable energy and climate adaptation projects.

Looking forward, the future of PFC and REC in the climate-focused finance landscape appears promising. As India’s economy grows, so will the demand for sustainable energy solutions. PFC and REC can significantly contribute to achieving India’s climate targets by scaling investments and expanding their mandates.

Green bonds and future avenues

These institutions’ renewable energy portfolios have grown impressively in recent years. For instance, PFC’s renewables portfolio expanded sixfold over the past six years to reach INR 482 billion (USD 6 billion). However, by leveraging innovative financing mechanisms, PFC and REC can potentially play an even larger role in supporting India’s energy transition.

One such avenue could be the increased issuance of green bonds, a crucial funding source for renewable energy initiatives. Both PFC and REC have already made strides in this arena. PFC issued its first USD Green Bond in December 2017 (USD 400 million) and its first Euro Green Bond in September 2021 for EUR 300 million (USD 315 million), both listed on major exchanges. As of March 31, 2024, its green bond portfolio has funded 13,492 MW of solar and wind projects, the value of which exceeds the amount raised through green bonds. REC raised USD 750 million through Green Bonds in April 2023, marking the largest-ever Green Bond tranche by a South & Southeast Asian issuer. In January 2024, it issued JPY 61.1 billion (USD 416 million) in Yen Green Bonds, the largest Euro-Yen issuance in the region, attracting strong international investor interest. Sustainability-linked bonds are another promising option, as they can tie the cost of capital to achieving specific sustainability targets, thus incentivizing projects to meet appropriate and stringent criteria.

Additionally, both institutions could explore international climate-focused finance mechanisms akin to the Green Climate Fund (GCF) and the Global Environment Facility (GEF), which offer substantial resources for large-scale renewable energy projects and infrastructure improvements. Strengthening relationships with international finance organizations will facilitate capital flow for large-scale projects. Establishing a dedicated climate-focused finance unit within PFC and REC can help identify funding opportunities, build partnerships with global financial institutions, and streamline access to international climate funds.

Public announcements and disclosures are now pivotal in mapping out the current strategies of PFC and REC, highlighting their progressive role in advancing sustainable development. These institutions are actively reshaping their financial approaches, prioritizing decarbonization, and diversifying portfolios to support a low-carbon future. With strategic initiatives and a commitment to innovative financing mechanisms, PFC and REC are uniquely positioned to drive India’s journey toward a resilient and sustainable economy, setting the stage for long-term environmental and economic benefits for all.

The three-part series will delve into “Transforming India’s Climate Finance through Sector-Specific Financial Institutions.” The third and final part will present frameworks and instruments to facilitate the flow of global green capital in India via these sector-specific entities.