Given India’s ambitious renewable energy targets, the availability of adequate financing is of prime importance. While there have been significant policy and regulatory changes over the past year, problems such as delayed payments by discoms and inadequate transmission infrastructure continue to bother investors. Meanwhile, new financing instruments such as green bonds are gaining traction. Financiers discuss their experience during the past year, the major risks and challenges, and the steps needed to create an enabling environment…
How has the renewable energy financing ecosystem evolved over the past one year? What has been financiers’ experience in this space?
A sustainable financing ecosystem is essential for achieving the ambitious renewable energy target of 175 GW by 2022. Some key initiatives taken in the past one year for strengthening the financing ecosystem are:
- Inclusion of renewable energy under priority sector lending (PSL) by banks and financial institutions: In the renewable energy segment, bank loans of up to Rs 150 million are now considered a part of PSL. For individual households, the loan limit is Rs 1 million per borrower. This will help finance small-scale projects in the renewable sector.
- Concessional finance: Financial institutions such as the Rural Electrification Corporation now extend loans to renewable energy projects at 75 basis points below the pricing of comparable conventional projects.
- Grant of Miniratna status to IREDA: The grant of the Miniratna status allows the Indian Renewable Energy Development Agency (IREDA) to make a capital expenditure of up to Rs 5 billion for new projects without government approval. This will give a boost to the sector as more funds will be available for financing projects.
- The Ministry of Finance has created the National Clean Energy Fund (NCEF). The clean energy cess being levied on coal is used to fund the NCEF.
In 2015, the annual global investment in new renewable capacity stood at $266 billion. This was more than double the estimated $130 billion invested in coal- and gas-based power stations in 2015. The trend was mirrored in India as well, with investments in the renewable sector crossing the $10 billion mark for the first time in 2015. As a result, the country’s renewable energy capacity has reached 45 GW, as of September 2016. The renewable sector has witnessed an increase in financing commitments from international agencies such as the World Bank, the International Finance Corporation (IFC) and the Asian Development Bank (ADB). Domestic banks are also supporting renewables through competitive terms and pricing. In addition to this, green/ masala bonds have found success over the past year as an effective tool to steer capital towards the sector. Regulatory measures through the Ujwal Discom Assurance Yojana are expected to lower the cost of debt for the power sector as a whole.
Over the years, the increased pace of capacity addition has significantly boosted stakeholder confidence. India has added over 10 GW of renewable energy capacity in the past 12 months, which indicates the seriousness of government support. Traditionally, debt financing for clean energy projects was mostly provided by commercial banks and a few non-banking financial companies (NBFCs). However, with the increasing number of projects moving from the under-construction stage to the operational stage, the perceived risks associated with such projects have reduced significantly, leading to increased participation by new lenders. While the current interest rates in this sector are in the range of 10.5-12 per cent, they are facing significant downward pressure due to decreasing inflation and the increasing supply of debt financing options. While the tenor of loans in this sector was initially 10-12 years, it has now gone up to 16-18 years due to increased confidence amongst lenders.
The progress achieved in the past one year has been healthy and among the various renewable segments, solar has seen the maximum traction while there has been some tempering of growth in wind energy. Banks have increasingly started lending to renewable energy projects that are backed by established promoters. The refinancing market is also witnessing aggressive competition amongst lenders and yields have dropped significantly. The financiers’ experience has been good as there have been few delinquencies. However, the future sustainability of these projects will solely depend on the financial health of the discoms and an enabling evacuation infrastructure.
There have been a number of notable developments in the renewable energy space over the past one year. There was a significant tariff reduction in the sector, especially in solar, as witnessed in Rajasthan where the lowest bid was Rs 4.34 per kWh. This shows that renewable power has come close to the pricing of conventional power in a short span of time and is now moving towards maturity. In addition, India has been building global partnerships and leading the promotion of renewable solutions. The partnership between India and France to form the International Solar Alliance, an association of 121 countries led by India to collaborate on increasing the use of solar energy around the world, will mobilise $1 trillion of investments in solar power by 2030. This is expected to boost solar installations significantly in the near future.
IFC, the largest global development institution focused on the private sector in emerging markets, has been a pioneering investor in the renewable energy sector in India, making steady investments since 2009 to assist private sector companies in setting up renewable energy projects. It has contributed to the expansion of clean energy access and the creation of job opportunities. As of June 2016, IFC’s total investment in renewable energy, including mobilisation, is over $1 billion.
Have the main sources of funding changed with the growth of green/masala bonds and yieldcos? Could these be the instruments of change in the sector?
Investors, both domestic and foreign, are warming up to the concept of “green papers”, and various banks and corporates have raised money for renewable projects by issuing green bonds. India’s green bond market took off this year, becoming the seventh largest green bond issuer, with $2.7 billion issued as of October 12, 2016, according to the Climate Bonds Initiative. The trend is expected to continue going forward.
The credit lines being provided by foreign and domestic banks are also mostly backed by green bonds raised in domestic or foreign currency. However, we are yet to see appetite for masala bonds for issuers, with the global rating below investment grade.
Meanwhile, the entry of yieldcos has opened up another avenue for capital infusion in the sector. It will help in monetising the operating assets and the capital released in the process could be used for further capex. Such structures are suitable for investors with a moderate risk appetite.
India has been able to develop a vibrant green/masala bond ecosystem for financing renewable projects. In February 2015, the first green bond was issued by Yes Bank to raise $150 million. Since then, India has risen to the seventh rank globally, having issued green bond issuances amounting to $2.7 billion as of October 2016. The Indian market has been well supported by the industry, government and regulatory authorities. With the right policy support, green and masala bonds are expected to grow further and become a major source of financing for renewable projects. While PSUs have been in the lead so far, more masala bonds are expected to be issued from other players as well. For example, Fullerton India became the first NBFC to issue masala bonds worth Rs 5 billion in October 2016.
Climate and green bonds are a new way of attracting foreign capital, which is essential for the growth of the sector. Some independent power producers (IPPs) and financial institutions have already adopted this route to raise funds. The green bond market is expected to reach over $60 billion next year and must be tapped by Indian institutions and IPPs. It will also attract new foreign institutional investors and pension funds to the sector.
Other funding instruments such as debt securitisation have not yet been utilised due to certain challenges with regard to tax and stamp duty, and the lack of capital market appetite. However, there is scope to tap this as an additional source of funding. Infrastructure debt funds (IDFs) can be another vehicle to raise funds at competitive rates. However, IDF financing can only be used to invest in operational projects.
Dr Ashok Haldia
The Indian renewable energy story has been well accepted by the global audience. As a result, a number of green/ masala bonds are being issued, which augurs well for the sector. The past one year has witnessed the evolution of a strong refinancing market domestically as well. The yields have reduced and tenors have increased, which has given the necessary financial resilience to the projects. However, I am not sure about yieldcos. As a concept, yieldcos are leveraged, have a high dividend payout and hence, a heavy dependence on cash flows. I believe that the Indian renewable energy sector is yet to reach that stage. Cash flows are still uncertain because of delays in payments from discoms. Under these circumstances, the return on equity is often at risk.
The yieldco model has been impacted of late, but many expect that India’s version, called infrastructure investment trusts (InvITs), will be successful. In essence, InvITs and yieldcos do the same thing – securitising an otherwise illiquid portfolio of largely commissioned assets to enable investments by retail and institutional investors that perhaps have a lower return expectation than the original developers. InvITs include important additional safeguards as compared to the yieldco model, with better separation between the original developer and InvIT management, valuations by independent assessors and a limitation on leverage.
What are the key considerations in selecting a project for funding? How do you see financiers’ interest evolving in the current circumstances?
Financiers take a holistic approach in assessing the potential of a project before funding. They assess diverse factors such as technology, location, implementation timelines, project cash flows, promoter creditworthiness and credit rating of the offtaker. The situation is quite stable in the wind energy space. However, the solar space is very dynamic as costs are coming down continuously. The timing of the order and the timelines for project completion have become equally critical for assessing the viability of these projects.
The key considerations for financiers are:
- The location (state) of the project
- The financial health of the discom
- The status of the power purchase agreement (PPA) and the agreed tariff of the project
- The past track record of the project developer
- The source and quality of the project equipment.
While there is a lot of interest to finance or refinance operational projects with long-term PPAs in place, under-development projects can also attract funding if the promoters/developers are credible.
Apart from the commercial terms, there are a number of considerations while selecting a project for funding. These include a detailed analysis of all the contracts such as the PPA, the operations and maintenance contract, and the engineering, procurement and construction (EPC) contract. Lenders also undertake a detailed resource assessment study such as of wind speeds for wind power and irradiation levels for solar power. This is followed by a detailed financial viability assessment.
Financiers’ interest in the renewable energy segment has been improving over the past couple of years. This will increase even further with the launch of the UDAY aimed at improving the health of the state electricity boards (SEBs). This is critical since mostly SEBs are the counterparties for the sale of power. A number of other steps need to be taken to ease the process of land acquisition and increase reliability in power evacuation. This, in turn, will increase the lenders’ comfort level.
Dr Ashok Haldia
Appraising a project requires a multi-dimensional approach. In project finance loans, the project needs to have adequate cash flows to service and repay the debt. The credit standing of the promoters and their willingness to support the project are also important considerations in the Indian context. As constant delays from discoms lead to a stretched working capital cycle, timely, though temporary, cash injections into the project from the promoters can help avoid delays in servicing debt. What we also look for is the relative importance of the project in the promoter’s overall strategic plan.
Apart from supportive promoters, other important considerations are the reliability of the technology supplier and the EPC contractor, and the robustness of the EPC contract. The EPC contract should be watertight, and delay and performance-related risks should be appropriately and adequately addressed. Another important aspect is the track record of the discom and the vigour of the PPA. The PPA should not include clauses with easy exit options for the discom and without any obligation. We are careful while financing such PPAs.
Both international and domestic investors are upbeat about the renewable sector. This is evident from the fact that India attracted over $11.8 billion of foreign direct investment (FDI) in renewables in the past year, the highest in the world. The government has set ambitious renewable energy targets, and made it easy for foreign investors to operate in the power sector by allowing 100 per cent FDI. This has also led to growing global interest in the Indian clean energy sector, which has seen large investments from international players and some major acquisitions in the recent past.
What initiatives need to be taken to facilitate further financing in the sector in order to achieve the 2022 targets?
- Mobilising international financial flows – Attracting global capital at competitive rates for funding renewable projects in the country is very important. A line of credit from multilaterals, masala bonds from Indian banks, grants/subsidies from focused funds, etc. may be some options. Mobilisation of funds through the International Solar Alliance may also be explored.
- Standardisation of project structures – The projects in the rooftop space will be small in size and large in number. For the efficient funding of these projects, standardisation of their structure is very important. It will provide comfort to international investors and financing entities to participate in these projects.
- Credit enhancement of projects – The power distribution companies in the country are in poor financial shape. Financiers are not very bullish on PPAs for utility-scale projects with these discoms. For credit enhancement of these projects, the government is facilitating projects where offtake and payments are tied up with entities having a better credit rating. However, certain improvements are required in these structures to make them more attractive such as guarantee for minimum offtake and debt servicing.
- Tax incentives – The entities funding renewable projects should be provided incentives in the form of lower taxes.
India is on the right path as far as the development of the renewable financing ecosystem is concerned. There has been real and visible support from the government in finding the means of patient capital for green energy projects. In October 2016, the India Innovation Lab for Green Finance endorsed three innovative investment vehicles for funding clean energy.
Dollar-denominated PPAs are definitely going to witness increased participation from international investors, who are wary of the fluctuations in Indian rupee. Further, lending by multilateral organisations and acceleration in issuing green/masala bonds will continue to be critical sources of capital. InvITs are also a promising avenue for tapping equity investments in completed and operating projects. The Securities and Exchange Board of India is at the final stages of finalising some modalities for InvITs. It has already received multiple requests for listing.
The 2022 target of 175 GW may or may not be achieved in time, and it will also depend on factors other than financing. The development of a stable financing ecosystem for renewable energy needs to be seen as an independent goal, which will serve the country’s requirements way beyond 2022.
Although the ambitious renewable energy plans of the government have given a huge fillip to the industry, some key issues need to be addressed. The health of the discoms, significant delays in the grant of approvals and land acquisition and uncertainty around technology/equipment meeting their output projections in the face of hostile climatic conditions continue to be areas of concern. The government has attempted to bridge this gap in infrastructure investments through a number of initiatives such as the IDF and the NCEF.
Dr Ashok Haldia
While lenders can manage project- and promoter-level risks, I believe the government should work on removing systemic risks; for example, receivables risk arising from delays in payments from discoms, and offtake risk arising from grid backdowns by discoms. Resolving these is critical to achieve the 2022 target. At present, the availability of capital for renewable energy projects is not a constraint, but it may become so in the future. We need alternative forms of capital such as mezzanine capital as well as securitisation of cash flows, in order to let the promoter recycle and reinvest its own capital while not being overly leveraged. As the sector grows and matures, we will need institutions and financing instruments that cater to every financing need of a project, not only during the implementation and operational phases but also when the project is at a terminal/stress level.
The government’s ambitious targets of achieving 100 GW of solar energy and 75 GW of wind energy by 2022 are important elements in meeting the “Power for All” agenda. To achieve these targets, new investments of over $100 billion will be required over the next few years apart from the investments needed in transmission and distribution. Since traditional bank finance may not be sufficient, India needs to mobilise investments from alternative sources of financing such as global banks and institutional investors like pension and sovereign wealth funds. Also, corporate bond markets and innovative structures such as green bonds and securitisation structures can be leveraged.
IFC was the first in India to issue green bonds and introduce other innovative financing mechanisms such as onshore maharaja and offshore masala bonds. These instruments are attracting more progressive and long-term investors, and enabling vast amounts of capital to be channelled to support a low-carbon climate-resilience path.