Accelerated Deployment of Renewable Energy Sector

Accelerated Deployment of Renewable Energy Sector Financial Instruments for catalyzing private sector investment for Indian RE sector Draft Report for Discussion Disclaimer

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This report has been prepared under the Technical Assistance titled “Supporting Structural Reforms in the Indian Power Sector” funded by UK aid from the UK government; however the views expressed do not necessarily reect the UK government’s ofcial policies. Contents 1. INTRODUCTION 7

2. GRID BASED RENEWABLE ENERGY 9

3. OFF-GRID/ DRE SEGMENT 37

4. IDENTIFYING FINANCIAL INSTRUMENTS 58

5. SHORTLISTED FINANCIAL INSTRUMENTS 69

6. WAY FORWARD – LARGER INTERVENTION REQUIRED 86 List of Figures

Figure 1: RE target in FY2022 and potential capacity in FY2030, sub-sector wise ...... 10 Figure 2: Source wise installed capacity in GW - Historical trend ...... 11 Figure 3: Recent bids and the capacity offered in India ...... 12 Figure 4: RE targets till FY2022 and current performance of key states ...... 14 Figure 5: Incremental RE capacity addition and Potential for gap to meet target ...... 18 Figure 6: Investment requirement in power sector and share of RE ...... 22 Figure 7: Stakeholders’ viewpoints at a glance ...... 23 Figure 8: Credit requirement and pool for power sector in India for FY 2017 – 2022, in USD Bn..25 Figure 9: Share of Banks and NBFCs in future commitments to the RE sector ...... 26 Figure 10: Marginal cost of capital of banks and cost of capital for NBFCs as on 26 Feb 2018 ...... 28 Figure 11: Risk free rate and typical borrowing cost of RE sector ...... 29 Figure 12: Credit Enhanced Bonds by ReNew Power ...... 31 Figure 13: Effective cost of foreign borrowing and domestic debt ...... 32 Figure 14: Exchange rate, INR/ USD ...... 32 Figure 15: State wise un-electrified rural households (as on 31st August 2017) ...... 38 Figure 16: Mini-grids/ DRE systems layout and typical business model ...... 40 Figure 17: DRE business models ...... 41 Figure 18: Stakeholders’ viewpoints at a glance – Overall Scenario ...... 42 Figure 19: Assessment of market potential for Off-grid sector in India ...... 46 Figure 20: Un-electrified villages to be covered under DDG scheme ...... 47 Figure 21: Independent mini-grid model ...... 48 Figure 22: Competency mapping of various agencies across the rural value chain ...... 49 Figure 23: Storage backed revenue based model ...... 50 Figure 24: Mini-grid operators enters into a strategic tie up with discom for connecting the un electrified areas ...... 51 Figure 25: BOT-o, Post grid extension: Discom owned model ...... 51 Figure 26: BOT-o, Post grid extension: Discom owned – Mini-Grid Operator managed model ...... 52 Figure 27: BOT-o, Post grid extension: Discom coverage model ...... 53 Figure 28: Lending potential to off-grid under PSL ...... 55 Figure 29: Immediate priorites emerging for scaling RE growth in sub sectors ...... 59 Figure 30: Effectiveness index’s parameters and ranks for Grid RE ...... 62 Figure 31: Scalability Index’s parameters and ranks for Grid and Off-grid RE ...... 64 Figure 32: Evaluation Matrix for instruments ...... 64 List of Figures

Figure 33: Relative ranking of ﬁnancial instrument for Grid RE sector ...... 65 Figure 34: Relative ranking of ﬁnancial instrument for DRE/ Off- grid RE sector ...... 65 Figure 35: Proposed structure of MFI backed masala Bond ...... 71 Figure 36: Proposed structure for PCG ...... 77 Figure 37: Current Structure of IDF...... 82 Figure 38: Investments from MFI ...... 83 Figure 39: InVITs Structure ...... 90 Figure 40: Renewable Energy Asset Platform (REAP) ...... 91 Figure 41: REAT Fund of Funds ...... 95 Figure 42: Framework for RE deployment in States ...... 97 Figure 43: Hybrid Investment Model ...... 99 List of Tables

Table 1: RE scenario in bottom five states (in terms of per capita income, excluding NE states) - States in increasing order of per-capita income ...... 15 Table 2: Key players – Incremental capacity addition for key players by FY 2022 ...... 16 Table 3: Profile of new/ potential entrants in the solar segment ...... 16 Table 4: List of new entrants...... 17 Table 5: Predominant risk in the sector ...... 18 Table 6: Stakeholders’ perspective on RE capacity addition by FY2022, in Gw ...... 21 Table 7: Summary of the stakeholder consultations ...... 23 Table 8: Current Lending terms of Banks and NBFCs ...... 28 Table 9: A brief snapshot of bond issuance by India corporates ...... 30 Table 10: Central government programmes supporting rural electrification ...... 39 Table 11: Levelised tariff for an MGO ...... 43 Table 12: Issues and possible solution for rural electrification ...... 49 Table 13: Category wise number of stakeholders consulted ...... 54 Table 14: Few MFIs funding in off-grid sector ...... 56 Table 15: Identified financial instruments for evaluation ...... 60 Table 16: New/ Adapted financial instruments ...... 66 Table 17: Possible structure for financial instrument ...... 74 Table 18: Possible structure of financial product ...... 78 Table 19: Possible structure for financial product ...... 83 Table 20: Regulatory Issues ...... 91 Table 21: State Wise RE Realization and Targets ...... 99 1. Introduction 1. Introduction

In order to meet the Indian Government target of 175 GW of renewable energy (RE) capacity by FY 2022, a capacity addition of approx. 25 – 30 GW per year is required over the next 4 years with an estimated annual investment of USD 15 – 20 Bn1 . By 2030, it is expected that around 300 GW of RE capacity shall be required to meet India’s commitment under COP21 (Intended Nationally Determined Contributions).

Since the predominant costs in RE relate to servicing of capital cost, rapid expansion requires access to adequate quantum of ﬁnance at low costs. This would in turn require innovation in equity and debt ﬁnancing on one part, and addressing the associated risks on the other. It would also be necessary to deepen the pool of capital available by attracting hereto less dominant sources such as bond market, international capital, etc.

Hence, there is a clear need to bring sophisticated ﬁnancing options to the sector to address speciﬁc requirements. In the recent times, the Indian market has witnessed some of this innovation but the ambit of this needs to be widened and scaled up.

The study seeks to assess the current financing landscape in the RE sector - for both Grid and Off-grid/DRE, with the objective to identify the gaps in availability and/ or access to capital (including cost of capital). Based on such assessment, the study will seek to develop options for providing intermediated finance to the sector which would suitably address the identified gaps. This study focuses on the grid scale ground mounted segment and distributed segment/ off-grid (solar home systems, micro grids, mini grids)2 .

The key findings of the study have been grouped into the following sections to address the objectives of the study. Chapter 2: focuses on Grid RE sector overview, and stakeholders view on financing challenges and predominant risk for the sector. This section also focuses on the status of RE targets of states and capacity addition targets of developers. Chapter 3: focuses on off-grid RE sector overview, and stakeholders view on financing challenges and key bottlenecks for the sector. This section also focuses on potential business model to help scale the off-grid RE segment. Chapter 4: focuses on the key emerging priorities for improving access to financing and increasing uptake of grid and off-grid RE and evaluate the various financial instruments for adoption. Chapter 5: examines the business case for final three financial instruments shortlisted for implementation.

1 KPMG Analysis 2 Excluding roof top solar (SRT) – which is being covered under MNRE’s TA programme for SRT

Accelerated Deployment of Renewable Energy Sector 2. Grid based renewable energy 2. Grid based renewable energy 2.1 Overview of Grid RE India has embarked on one of the largest renewable energy (RE) capacity expansion programs in the world. India has set an ambitious target to develop 175 GW of renewable capacity by the end of FY2022 to harness the RE potential and as a measure towards energy security and climate management. India has further committed to achieving a 40% share of non-fossil fuel sources in India’s overall capacity by 2030. In line with it, it is expected that RE capacity in FY2030 may reach ~300 GW3 .

Figure 1 RE target in FY2022 and potential capacity in FY2030, sub-sector wise

RE growth target capacity Expected growth subject to demand growth

Key focus RE sectors 100-125

83 275-300 175 2 27 62

Installed as of Bio + SHP Wind Solar RE Expected Installed Dec 2017 Capacity FY Capacity Capacity FY 22 Addition 30

Source – MNRE and KPMG analysis based on estimates of demand and supply from other conventional sources as well Note: RE installed capacity is as on December 2017

The annual capacity addition in the RE sector has increased from 200 – 300 MW in early 2000s to 3,000 – 7,000 MW in the last four years. In FY 2017, the sector witnessed its highest ever capacity addition of 15,000 MW driven by an intense government “push” to meet RE targets and improving economics of RE. The installed capacity in the sector has been growing at a CAGR of 19% in the last six years i.e. FY 2012 to FY 2017, with capacity growing at 36% in the last year alone. Solar and wind segment, contributes to about ~77% of the overall RE capacity as on FY 2017. The ﬁgure 2 below highlights the historical installed capacity trends.

3 Assuming an electricity demand growth of ~6% CAGR (FY2016 – 2030); the long term growth in RE capacity will be dependent on the generation cost of such sources and emergence of viable technologies for grid integration (to manage intermittent and variable nature o RE sources). Availability of continuous land is also a key determinant in long term capacity addition.

Accelerated Deployment of Renewable Energy Sector Figure 2 Source wise installed capacity in GW - Historical trend4

70 Renewbale Energy Installed Capacity 57 60 CAGR - 19% 13 50 42 35 40 32 12 12 24 28 12 30 11 7 7 4 20 6 1 3 0 27 32 Installed Capacity (GW) 23 10 17 19 21 - FY 12 FY 13 FY 14 FY 15 FY 16 FY 17

Wind Solar Other RE

Source – CEA, NIWE, MNRE and KPMG analysis

With nearly 32 GW of wind and 12 GW of solar capacities, India is today ﬁrmly within top 3 or 4 position globally in both solar and wind installations.

However, the capacity addition has slowed in ﬁrst three quarters of FY 2018, as only 5 GW (out of which 4 GW is solar) capacity got commissioned i.e. 8% growth for ﬁrst three quarter for FY 2018.

2.1.1 Increasing competitiveness of solar power

Solar power inﬂux is emerging as a key discontinuity in the global electricity supply scenario including India. Of the targeted 175 GW of renewables capacity by FY 2022, solar capacity is 100 GW.

Recent years have seen a steep acceleration in growth in solar segment, with two-third of the total solar installed capacity (at the end of FY 2017) installed in the last two years itself. Its capacity share in the overall RE sector has increased from ~0.2% in FY 2012 to ~21% in FY 2017.

Reduction in generation cost is estimated to be the key driver for solar absorption. Solar tariffs have dropped 84%5 over last 6-7 years, to new low of Rs.2.44 per unit in 20176 . With steep reduction in tariffs, grid based solar energy has become cheaper than conventional sources in most states. As can be observed from the ﬁgure 3 below, the tariffs quoted have declined by almost 50% alone in last twelve months7 . The falling solar tariffs have been largely driven by the expected future drop in module prices, ﬁnancial engineering and economies of scale associated with larger projects. Further, risk mitigation structures such as better payment security provided in some bids as well as deemed generation recently provided in case of REWA have also resulted in more attractive terms for these bids.

4 Installed Capacity for Wind and Solar as on March 2016 and installed capacity for other RE Sources which includes Small Hydro Power and Bio Power as on Dec 2015. 5 From Rs 14.90 per unit in 2010 to 2.44 in 2017 6 For Solar Park in Rajasthan the lowest tariff bid was INR 2.44 per unit. 7 May 2016 to May 2017

Accelerated Deployment of Renewable Energy Sector Figure 3 Recent bids and the capacity offered in India

Trends of solar tariff in competitive bidding

1600 1500 1500 9 1400 8.04 1200 8 1200 1200 7 6 1000 5.73 5.62 5.65 5.76 5.12 5.19 5.46 750 5.36 4.63 4.66 5 4.35 4.78 4.79 4.85 3.47 5 800 4.63 4.35 3.30 2.62 MW 4 500 500 500 500 500 500 500 INR/kWh 600 420 3.15 350 350 350 2.44 2.66 250 3 300 250 2.47 400 215 170 2 150 150 100 130 100 2.48 200 1 0 0 TN (Jul-17) PB (Sep.15) GJ (Sep-17) JH (Mar-16) KR (Mar-16) UP (Jun. 15) UK (Oct. 15) HR (Dec. 15) MP (June 15) TL 1 (Aug. 15) Reva (Feb-17) TL 2 (Aug. 15) NSM RJ (Jan 16) NSM AP (Apr-17) SECI RJ (Dec-17) SECI RJ (Dec-17) SECI RJ (May 17) NSM TL (May-16) NSM RJ (July-16) SECI RJ (May-17) NSM KK (Apr-16) NSM AP (Dec. 15) NSM AP (Nov. 15) UP-bundling (Jan 16) NSM KR DCR (Sep-16) NSM AP DCR (Dec. 15)

Capacity on offer Lev. tariff (INR/kWh)

Source –Media reports & KPMG analysis

In discussions with various stakeholder, it came out that bids under INR 3 per unit are aggressive and debatable. However, various industry participants are fairly convinced of bids ranging between INR 3 – 3.25 per unit which, itself is lower than conventional power plants and in some cases (e.g. Haryana), variable cost of power plants. 2.1.2 Changing dynamics in wind sector

Capacity addition in wind based power has been historically driven by ﬁscal incentives including Accelerated Depreciation (AD) and Generation Based Incentives (GBI). However, the dynamics in the wind energy sector is set to change with introduction of competitive bidding regime coupled with improving technological advancements.

Competitive bidding: The tariffs discovered in wind power reverse auction have fallen from INR 3.46 per unit in Feb 2017 to INR 2.44 per unit in Feb 2018 , which is ~40-45% lower than current feed-in-tariffs ranging from INR 4-4.5 per unit. The auctions reinforces wind energy’s business model as lower tariffs would make wind energy more palatable for ﬁnancially stressed power distribution companies (discoms) and pave the way for more capacity additions. Moreover, success in inter-state bidding could open up new markets for the wind sector, i.e. non-windy states which need to procure wind to fulﬁl their RPO and project a green image.

Accelerated Deployment of Renewable Energy Sector Technological advancements: Some of the OEMs are in the early stages of introducing turbines of capacity greater than 2.5 MW. The hub heights are also seeing an increasing trend. The technology improvements are likely to increase PLFs considerably. While initially costs may increase, overall, there is expected to be net improvements in terms of better returns/ lower tariffs.

2.1.3 Other RE sector

Biomass: India has a target to set up 10 GW of biomass-based power capacities by FY 22. Apart from being a more ‘stable’ source of clean energy, biomass-based power plants can be an important driver for rural development — these can not only effectively address the issue of energy access (through biomass-based minigrids), but also contribute to the rural economy in terms of revenues for biomass feedstock procurement. The growth of this sub-sector in the last 3–4 years has been constrained by issues such as fuel procurement, plant performance and inadequate tariff hikes, keeping in view the increase in feedstock prices. A revival of this sector would require key initiatives in areas such as technology improvement, tariff design, conducive state policies, effective procurement mechanism for feedstock, reduction of ﬁnancial stresses through reﬁnancing on favorable terms, etc.

Small Hydro: India has an estimated potential of 20GW of SHP projects. The central government has issued a national mission for SHP, which aims to develop new-generation facilities and rehabilitate and upgrade existing schemes. The mission envisages development of 5GW of SHP by FY20. However, given the constraints associated with hydropower development and presence of solar as a better alternative for remote and rural areas (in terms of capital cost, gestation, clearances, etc.), the outlook for small hydro development is weak. Accordingly, there is substantial inertia in this sub-sector.

2.2 India’s ability to meet RE targets 2.2.1 Status of state’s RE target

The ability of states to meet existing targets and move towards enhancement of targets would depend upon a host of factors including state’s electricity demand and contracted supply, enforcement of renewable purchase obligations, discom ﬁnances, ability to integrate RE as well as effective resolution of challenges such as land availability, adequate transmission infrastructure, etc.

The state wise RE capacity addition compared to the targets is presented in below for the major states in India (based on RE targets).

Accelerated Deployment of Renewable Energy Sector Figure 4 RE targets till FY20228 and current performance of key states

Status of target achieved by key states 60% KR TN 45% RJ GJ AP MP MH 30% PB UP 15% BR HR WB % Achieved as on Dec 2017 DL 0% 0 5 10 15 20 25 Target - FY '22 (GW)

Source – MNRE and KPMG analysis; Data of installed capacity as on December’17

As evident from ﬁgure above, most of the states are in initial phase of RE capacity addition which is explainable, given it is only three years since the momentum in solar has gathered pace9 . However, southern region states such as Karnataka (KR), Tamil Nadu (TN), Andhra Pradesh (AP) and a few western region state such as Gujarat (GJ) have led the growth in RE driven by the wind segment which had a head-start on solar by several years in India. These states cumulatively have ~ 33 GW of installed RE capacity as on December 2017.

Going forward, performance of states such as Rajasthan (RJ), Gujarat (GJ), Andhra Pradesh (AP), Maharashtra (MH) and Tamil Nadu (TN) will be critical for India to achieve its target of 175 GW by FY2022. These states have already facing concerns such as transmission bottlenecks, back down of RE generation and issues of grid integrations.

States such as Rajasthan and Madhya Pradesh have ramped up the capacity addition in the recent times and together have an installed capacity of 11 GW.

However, capacity addition needs to pick up pace in states such as UP, Punjab, Haryana and West-Bengal which have signiﬁcant untapped potential but have seen only ~5 GW of RE installations till December 2017.

RE scenario in some of the states with low per capital income (for FY 2015) is presented below. These states have been clearly lagging behind in their efforts to integrate clean energy in the state power plans, possibly constrained by factors such as discom ﬁnances and high risk perception with investors, etc.

8 Achievement as on December 2017 9 Out of 175 GW target 100 GW is Solar

Accelerated Deployment of Renewable Energy Sector RE scenario in bottom ﬁve states (in terms of per capita income, excluding NE states)10 - States Table 1 in increasing order of per-capita income

RE installed RE potential, RE target, Target Potential States 11 capacity as on in GW in GW FY2017, in GW12 realization (%) Realization (%)

Bihar 13 3 0.3 ~10% 2%

Uttar Pradesh 28 14 2.5 18% 9%

Jharkhand 19 2 0.03 1% 0.2%

Madhya Pradesh 67 12 4.0 33% 6%

Odisha 28 2 0.1 8% 0.4%

Total 155 33 6.9 21% 4%

Source – MNRE, CEA, KPMG Analysis

In the long term, capacity addition in RE will be driven by overall growth in demand, better RPO compliance, reduction in cost of generation of RE sources and better planning for integration of RE (to mitigate variability in RE sources). Further, it would be important to focus on a broad based participation amongst states, to not only create more demand for RE but also to address the issue of energy security for these states. It is important to develop a plan to include some of the poorer states such as Bihar, Jharkhand, Odisha, etc. which have RE potential but have not seen much of development. 2.2.2 Capacity addition targets of Developers

The key players in the grid-scale RE are in a growth mode with aggressive renewable capacity additions planned across varies states in India. Of the current RE installed capacity of ~63 GW as on December 2017, these contribute to about 20 -25% of the market share i.e 12-15 GW. Going forward, based on various announcements and stakeholder consultations it is understood these companies are targeting a capacity of ~70 – 80 GW by FY 2022.

10 Source: http://pib.nic.in/newsite/PrintRelease.aspx?relid=123563 11 Including wind potential of 103 GW (and not ~300 GW at 100m mast height) 12 As on March 31, 2017

Accelerated Deployment of Renewable Energy Sector Table 2 Key players – Incremental capacity addition for key players by FY 202213

Incremental capacity target Key Players (GW) till FY22

0 - 5 Acme, CLP, First Solar, Tata Power

Hero Futures, Green Infra, NTPC, Azure, Adani, Greenko, 5 - 10 Mytrah, ReNew

Sources-Media reports, RE-Invest MoUs signed, KPMG Analysis, Primary Interactions

The key players are expected to contribute ~42% of the targeted capacity by FY 2022, amounting to ~73 GW. Given various sector risks such as delay in signing PPAs, contract re-negotiations, delay in payments by state distribution companies, counter party risk, as well as risks of revisions in targets owing to company related factors, it may be prudent to assume that 40 – 60 GW of RE capacity in FY 2022 will be contributed by these key players.

In addition, there is considerable interest from new entrants into this space. Announcements made by some of the larger players are shown below:

Table 3 Proﬁle of new/ potential entrants in the solar segment

Entrant Proﬁle14

Ÿ Won 350 MW NSM tender in AP (Dec. 15) at INR 4.63/ kWh SBJ Cleantech Ÿ Signed MoU with Government of Rajasthan to develop 1 GW solar capacity by December 2017

Sany Group, China Ÿ Announced plans to develop 2 GW of solar capacity in India

Ÿ In partnership with the Dubai based PE investor Abraaj group to Aditya Birla Group develop 1 GW of solar worth USD 1 Bn. in next 5 years

Ÿ Announced plans to develop 1GW solar and wind parks across Embassy Group India over the next 5 years Ÿ The government owned Finnish power developer has 15 MW of Fortum solar power projects commissioned and 170 MW under construction Ÿ Plans to invest 400 million euros in the sector in the near future

13 Capacity addition moderated from RE-Invest targets 2015 based on primary interactions and desktop research; Data extrapolated till FY 22 based on year on year historic capacity addition trends for respective players. Figures will be vetted as more stakeholder consultations take place 14 The analysis currently excludes Sky power as their plans for India are uncertain as per market news

Accelerated Deployment of Renewable Energy Sector Entrant Proﬁle14

Avada Power Ÿ Avada Power has won 100 MW tender in Badhla Solar Park

Ÿ Phelan Energy Group Ltd, a prominent South African based Phelan Energy international investment and development company. Their focus is exclusively on investments in large solar plants, ranging from 10 MW–200 MW

Cumulatively, capacity of more than 10 GW over the next 3-5 years has been announced by these new entrants. The sector has already started witnessing some of these entrants emerge winners in the latest solar auctions.

Table 4 List of new entrants

Sl. No Entity Solar Auctions Capacity Won (MW)

1 Solenergi Rewa Bid 250

2 Mahindra Solar Rewa Bid 250

3 SBJ Clean Tech Badhla Phase III 500

4 Phelan Energy Badhla Phase IV 50

5 Avada Power Badhla Phase IV 100

Source : Industry Analysis

However, based on experience and consultations with a few of these players, it is expected that the new entrants will tend to consolidate their initial investments, gain understanding of sector dynamics as well as experience of operating in India, and then follow a steady and well considered strategy to expand further.

Taking into account expected capacity addition from key players and new entrants, it emerges that 50-65 GW gap may still remain in achieving capacity targets. This may involve greater participants from new and smaller players. This underlines the need for a robust ecosystem which facilitates participation of new entrants in the sector and also enables smaller participants to scale up.

Accelerated Deployment of Renewable Energy Sector Figure 5 Incremental RE capacity addition and Potential for gap15 to meet target

50 - 65 175

5 - 10 40-60 GW 62 Gap will also depend on the overall target by FY2022

Installed Capacity Key RE players - New Entrants Gap Total incremental

Source – KPMG Analysis

A key constituent of the robust ecosystem will be to address predominant risks and challenges in the sector to scale up broad based growth in the sector. Such risks are discussed in subsequent section.

2.3 Stakeholder perception on predominant risks in grid RE sector Risk perception of stakeholders and availability of risk management strategies is a critical factor affecting investment decisions. Accordingly, perspective of various ﬁnanciers and developers on key sector risks has been collated as part of the stakeholder discussion. The ﬁndings are presented below:

Table 5 Predominant risk in the sector

Risk Perceptions Risk Category Foreign Lender Domestic Lender Developer

Land Availability Risk

Technology Risk

Regulatory Risk

Curtailment Risk

Off-taker Risk

Contractual Risk

High Risk Medium Risk Low Risk Source - Primary Interactions and KPMG Analysis

15 Analysis based on FY 2017

Accelerated Deployment of Renewable Energy Sector As evident from the ﬁgure above, key risks perceived by the stakeholders are, off-taker risk (payment delays), curtailment risk (back down of RE generation) and contractual risk (re-negotiation & cancellation of existing PPAs). Further, a few domestic lenders and power developers also raised concerns around technology risks.

Ÿ Off-taker risk: Concerns regarding creditworthiness of discoms and their ability to honour dues affects bankability of PPAs and attractiveness of projects where discoms of certain states are the off-takers. While payment defaults have so far not been experienced in the country, average payment delay of 6-9 months or more is increasingly becoming a norm in several states16 . With narrow margins prevalent in the industry, payment delays could severely impact investor returns. This risk is a signiﬁcant issue for all categories of stakeholders. While developers generally agreed that the issue is more in terms of delay in payment than default, some of the ﬁnancing institutions indicated that this could result in a ‘no-go’ decision while evaluating projects.

Ÿ Curtailment risk: It is driven due to concerns regarding willingness and ability of the discoms to schedule power from the RE projects irrespective of the PPA terms and overall demand-supply scenario. While RE enjoys a “must run” status, in the last couple of years, wind projects (and recently solar projects) have faced curtailment, with grid availability issues being cited as the reason for curtailment. Evacuation infrastructure does pose a challenge in some states, and the need for enhancing transmission in the country as well as implementing robust forecasting and scheduling mechanisms are key imperatives. Going forward, signiﬁcant transmission infrastructure is planned by the country which if implemented in a timely manner could help mitigate some of these risks.

Further, the risk of economic curtailment is also increasing with oversupply situation and poor ﬁnancial health of the discoms, especially for some of the older RE contracts which would have been signed at rates higher than cost of conventional generators at the margin. Such situation could lead to a perverse incentive to curtail RE power owing to commercial considerations. In fact, the state regulator in MP has recently proposed that RE generators be subjected to scheduling and merit order dispatch principles. This would in effect take away the must run status for the generators. Unanticipated situations such as possible back down of RE generators will impact investor returns affecting investor sentiments.

Ÿ Contractual risk: The contractual risk is driven due to concerns of discoms not honoring the PPAs they had committed to at higher tariff, without any legal grounds or force majeure conditions. With every round of auction, the RE tariffs are falling which puts the existing PPAs in risk of not being honored. The events have led to significant uncertainty for developers and financers who have committed investment in the sector based on the signed PPAs. This also puts the larger sector at risk in terms of loss in investors’ confidence and increase in capital cost.

Ÿ Technology risk: Concerns regarding quality of modules being used were also highlighted by some of the lenders. There were also concerns that in Indian conditions, panel degradation may be higher than anticipated impacting the future revenues. It was suggested, the sector requires standards and certiﬁcation of module similar to the certiﬁcation of turbines in the case of wind sector. There is also a need of a credible organization for independent testing of working of panels in Indian conditions.

16 Based on the stakeholder discussions

Accelerated Deployment of Renewable Energy Sector It is important that critical concerns of the stakeholders are addressed so that the potential of RE can be optimized fully in terms of wider sector participation, greater access to capital and at cheaper cost. Towards this end, risk mitigation measures along with ﬁnancial innovation are important to bring down costs and accelerate the RE growth. For e.g, in the case of the Rewa Solar Park, risk mitigation structures led to signiﬁcant reduction in risk and thus reduced the tariff by ~45-50 paisa per unit. The same is presented in the box below:

Box 1 Project Structuring in Rewa Solar Park led to controlled key risks

Project structuring has led to reduced risk and thus low cost of capital

5.0 4.6 CapEx Project structuring led to better capital terms INR 4-4.5 Cr/MW 0.3 4.0 3.8 0.1 0.1 3.3 3.0 Capital Structure Reduced Reduced

INR/kWh 2.0 80:20 Working Equity IRR Debt@ 10% for Capital expectations 18 years 1.0

Earlier Tariff Capex & O&M Debt Term Working Capital Equity Returns Rewa Bid

§ Payment Risk: State Government payment guarantee if procurer does not pay in time § Curtailment Risk: Non/Partial availability of Transmission system and backing down from RLDC will be considered as deemed generation – for grid unavailability beyond 50 generation hours § Offtake Risk: Guaranteed minimum energy offtake by procurer, in case of shortfall, procurer will compensate developer for the shortfall - min offtake is 24% CUF

2.3.1 Stakeholders view on India’s RE targets

The industry in general shares the exuberance. In a recent interaction with various industry stakeholders, majority of the participants were conﬁdent of India achieving its grid scale solar and wind targets by FY2022. There were some apprehensions on the roof top solar targets but there again, the consensus was that the segment is evolving and with supportive policy environment, can take off quickly.

Accelerated Deployment of Renewable Energy Sector Table 6 Stakeholders’ perspective on RE capacity addition by FY2022, in GW

States Solar-grid Solar roof-top Wind Total

Target (MNRE) 60 40 60 175* Developers 60 – 70 10 – 20 40 – 50 125 – 155 Domestic lenders 50 – 60 10 – 20 40 – 45 115 – 135 PE investors 40 – 50 5 – 10 40 – 50 100 – 125 Shortfall in target (10)** – 20 20 – 30 15 – 20 20 – 75

*15 GW from other RE sources **Surplus Source: Stakeholder discussions

As evident from the above, broad consensus in the RE sector is that India will be able to achieve ~125 GW by FY2022 based on the existing efforts and resources, achieving a commendable threefold increase from the installed capacity (when targets were set). Moreover, the possibility remains that India will achieve the full target, albeit with some delays.

Based on stakeholder discussions, the key challenges which needs to be addressed to sustain the momentum in RE growth are:

Ÿ Enabling risk mitigation structures to address commercial risks like payment delays, curtailment risks and strong enforcement by regulatory and legal authorities to honor existing PPAs.

Ÿ Financial innovations to help accelerated growth of renewables in India, ﬁnancial innovations will debottleneck adequate quantum of low cost capital needed to scale up RE capacity addition.

2.4 Future Financing Pre-Requisites 2.4.1 An exponential growth required in investments Keeping in view the central RE targets, it is estimated that between FY 2017–2022, investments to the tune of USD 9517 Bn is required in the RE sector, nearly three (3) times the investments till date. Even assuming some delays, it is estimated that USD 69 Bn would be required to support a capacity addition of 14018 GW by FY 2022. This implies an annual investment requirement of over USD 15-20 Bn. Including other segments such as conventional generation, transmission and distribution, the annual requirement would be approximately USD 35-40 bn. The annual requirement can further increase by ~5 Bn in lieu of capital requirement for thermal power plants to comply with the new environment norms, which is USD ~2519 Bn in the span of five years. This is a significant step up as the capital flows to the overall power sector has typically been in the range of USD 20-25 Bn in the last few years.

17 RE inclusive of Solar, Wind, Small Hydro and Bio Power estimated based on the base year FY 2016 18 Based on primary interactions capacity additions of Wind and Solar rooftop has been moderated by 15 and 20 GW respectively by FY 2022 19 KPMG Analysis done for Environmental Impact Assessment

Accelerated Deployment of Renewable Energy Sector A further USD 71 Bn is estimated to be required between FY 2023 and 2030 for RE to meet the ambitious INDC goals for decarbonizing the economy.

Figure 6 Investment requirement20 in power sector and share of RE

300 250-280 50% 43% 41% 45% 39% 250 37% 38% 217 40% 31% 35% 200 183 25 30% 149 19 150 62 25% 14 50 USD Bn 111 20% 100 10 40 71 29 15% 6 123 10% 50 28 18 91 108 69 5% 5 45 - 20 0% FY 17 FY 18 FY 19 FY 20 FY 21 FY 22 FY 23-30

GTD Solar Wind Other RE RE Share (%)

GTD includes – Investments in Conventional generation + Transmission + Distribution (excludes capital requirement towards - grid integration and new environmental norms. Source – KPMG Analysis, GOI RE targets and CEA – draft National Electricity Plan – Dec 2016

2.5 Challenges in financing for Grid RE It is expected that with lenders having high exposure to power sector and with RE sector facing challenges, financing bottlenecks could emerge for the RE sector especially where project or sponsor risks are perceived to be higher. Accordingly, in order to evolve instruments which could catalyse low cost capital into the RE sector, extensive stakeholder discussions were conducted to analyze the current and expected financing gaps for the RE sector in India and the interventions required to address the same. The stakeholders identified for the consultations covered all categories/strata as indicated in the table below:

20 Not considering grid integrated costs

Accelerated Deployment of Renewable Energy Sector Table 7 Summary of the stakeholder consultations

Number of Type of stakeholder Sub-categories stakeholders contacted

Financiers Domestic Lenders 3

NBFCs 5

IDFs 2

International Financial Institutions / Funds 6

Multilaterals 2

Private Equity/Venture Capital 3

Project Large Developers (by Portfolio) 8 Implementers Small Developers (by portfolio) 2

Others Intermediaries21 6

Total 37

Through desktop research and understanding of the RE sector, key themes of challenges in RE financing were identified, and were discussed with stakeholders to understand their viewpoints regarding the same. The key themes identified were – (i) Requirement of new sources of capital (ii) Reduction of cost of capital (iii) Requirement of monetization avenues. Basis these themes and discussions with stakeholders following viewpoints emerged:

Figure 7 Stakeholders’ viewpoints at a glance22

High cost of Capital 80%

Availability of Debt 55%

Availability of Equity 50%

Lack of Monetization Avenues 35%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Note: Percentage represents the proportion of stakeholders agreeing with the issue

21 Includes : Rating agencies, Insurance companies, Merchant bankers 22 Based on primary interactions with stakeholders

Accelerated Deployment of Renewable Energy Sector While stakeholders have widely acknowledged that all the issues discussed would need to be addressed at some level to ensure a rapid scale up of the sector, high cost of capital emerged as the overarching area of focus. Though, lack of monetization has emerged as the least of all the concerns, the concern is rated high by PE players (67%).

There were differences seen in opinions within different stakeholder categories which also need to be kept in view while designing interventions. The sections below, discuss in detail each of these issues, along with stakeholder viewpoints on the same keeping in view different categories of stakeholders. 2.5.1 Whether capital in the order of the magnitude required will be available To analyse whether funding requirements for RE scale up will be met, we have evaluated the availability of debt and equity considering the following: Ÿ Projections for availability of debt to the power sector based on past trends in growth of credit availability to the sector Ÿ Additional debt commitments to the RE sector Ÿ Equity availability to project implementers

2.5.1.1 Projections for availability of debt to the power sector In the last seven years i.e. FY 2011 – 2017, banking sector’s credit to industry sector has grown at a CAGR of 9% and typically the share of power sector has been in the range of 19%-21% in the industrial credit in the last few years.

The estimates for future credit availability to the power sector have been arrived at assuming credit growth for the industry based on historical rate and share of power sector at ~20% of industry credit. For NBFCs, historical credit growth of an average of 16% has been considered.

The debt requirement for the sector is based on the CEA estimates of capacity addition for the 13th Plan period for the conventional capacity and GOI targets for RE. For transmission it has been taken from Draft NEP 2016 (Transmission Volume) and distribution investments, based on historical capital expenditure23 .

Based on the above, gap in the credit pool for debt financing has been estimated. The figure below estimates the gap in debt financing from key existing sources.

23 Sourced from Working group report on power for 12th Plan, this does not take into capital expenditure towards grid integration

Accelerated Deployment of Renewable Energy Sector Figure 8 Credit requirement and pool for power sector in India for FY 2017 – 2022, in USD Bn24

40 (18) 34 (16) (16) 35 31 32 (14) (14) 30 29 28 28 (11) (12) 24 (10) 25 22 22 (8) (8) 20 19 17 (6) USD bn 15 (4) Gap (USD bn) (2) (2) 10 8 - 5 2 2 - 4 FY 17 FY 18 FY 19 FY 20 FY 21 FY 22

Total Credit Available (YoY) Debt Required Gap

Source – KPMG Analysis; CEA – Draft National Electricity Plan (December 2016), GOI RE targets

The gap in credit pool is higher in the initial years, to the tune of USD 11-16 Bn indicating ~50% to ~40%25 shortfall in meeting funding requirement, and it reduces subsequently. Moreover, ssigniﬁcant proportion of the conventional capacity, scheduled to be commissioned between FY 2017- 2019, is assumed to have tied up the ﬁnancing requirement. Thus, this capacity is likely to be in the priority for the capital access. RE may need to compete for the remaining capital available along with the incremental conventional capacities and transmission and distribution investments planned. Hence, the RE capacity which is planned to come up in this period may have to explore newer sources of capital, other than the traditional sources in case if the availability of capital is constrained.

This is also evident from the total commitments made by domestic financial institutions including NBFCs to the RE sector. The total commitment till FY 2022 is USD 57 Bn as against an estimated requirement of USD 95 Bn (even with some delays in capacity addition, the requirement would still be ~USD 70 Bn). The figure below highlights the commitments by key institutions to RE sector in India for the next five years.

24 Capacity addition for renewable energy sources assumed as per GoI 175 GW targets (from FY 17 – FY 22) Capacity addition for conventional sources as per CEA (from FY 17 – FY 22) as published in Dec’16 Debt to Equity ratio considered to be 75:25 for conventional and 80:20 for RE sources Debt Requirement inclusive of Transmission and Distribution Network Addition 25 As a percentage of total debt requirement

Accelerated Deployment of Renewable Energy Sector Figure 9 Share of Banks and NBFCs in future commitments to the RE sector

SBI 20% ICICI Bank 27% L&T - NBFC PFS IREDA 10% Yes Bank 4% IIFCL 4% 9% PFC 5% IDBI 7% 8% Others 8%

Source: MNRE, Lok Sabha Questions - March 2016

This clearly indicates that there could be a funding gap, against the estimated debt requirement to support RE capacity addition.

The gap may further increase if issues such as power sector NPAs are not resolved or growth in overall credit of the banking sector is below expectations. In such a scenario, it is important to deepen the pool of capital available for new projects as well as facilitate reﬁnancing of existing debt to create capacity with existing lenders. Alternate capital pool such as domestic bond market and international capital, needs to be tapped through innovation in ﬁnancial instruments.

2.5.2 Equity availability in sector The equity availability in the sector is primarily dependent on sponsor equity. There has been a lot of traction in the private equity space as well. However, private equity capital has largely backed leaders in the RE space and large platforms. It is likely that smaller players will continue to be largely dependent upon sponsor equity.

The key viewpoints of stakeholders with regard to availability of capital has been captured below:

Accelerated Deployment of Renewable Energy Sector Box 2 Summary of the stakeholder responses with respect to availability of capital

Debt • Availability of debt may be a constraint for new and small developers though it is unlikely to be an issue for good projects / established developers • State speciﬁc biases in capital availability may become more pronounced as issues such a payment delays, despatch risks etc. are experienced with projects in certain states

Equity • Availability of equity from PE investors is skewed towards established companies • There is no immediate equity requirement of large players as most of the projects have tied up their funds for the next 2-3 years

Key takeaway • Projects with bigger platforms/ sponsors holding diversiﬁed portfolio may get a preferential access to capital since lenders have more conﬁdence with respect to the ability of sponsors/ platforms to fund project overruns and unforeseen working capital requirements • Availability of capital could be an issue for projects associated with states which carry a higher risk perception. • Stakeholder wise strength of opinion

Issue Description Lenders Developers PE/VC/IB

Debt Pool Unavailability of 78% 50% 0% Debt

Equity Pool Unavailability of 33% 50% 100% Equity

- It is to be noted that 78% of lenders have rated availability of debt as the top concern. This indicates that this could emerge as a key bottleneck. - All the PE Investors and smaller developers have prioritized availability of equity to small developers as the key concern.

Accelerated Deployment of Renewable Energy Sector 2.5.3 Limited avenues to reduce cost of capital 2.5.3.1 Little room for rate reductions for banks and NBFCs As per the recent guidelines of RBI, the lending rate of commercial banks is now based on Marginal Cost of Lending (MCLR) of banks. The table below highlights the MCLR for banks (1 year) and cost of capital of NBFCs, plotted against their commitments for RE sector (in USD Bn).

Figure 10 Marginal cost of capital of banks and cost of capital for NBFCs as on 26 Feb 2018

10% Other Banks

9% PFS Yes Banks IREDA REC SBI 8% ICICI Banks

7% MCLR (1 Year) %) MCLR (1 Year)

- 2 4 6 8 10 12 Investment Committed (USD Bn.)

Source: Respective banks and primary interactions

As apparent from the ﬁgure above, MCLR for majority of the ﬁnancial institutions is ~8.5-9%, and cost of capital of NBFCs is also close to 9%. The lending rate to the RE sector is currently between 9% - 10.5% (see table below) which implies a spread (risk premium + NIM) of 0.8% – 1.5%. This implies that there is limited margin for these institutions to reduce the cost of debt.

Table 8 Current Lending terms of Banks and NBFCs

Nationalized Private Gov. Private Parameter banks banks NBFCs NBFCs Interest rate 9.5 – 10.5% 9.5 – 10.5% 9-10.5% 9.5 – 10.5%

Tenure – Yrs. 16 – 19 17 – 2126 16 – 19 17 – 2127

26 With reﬁnancing 27 With reﬁnancing

Accelerated Deployment of Renewable Energy Sector Nationalized Private Gov. Private Parameter banks banks NBFCs NBFCs D-E ratio 75 – 25 75 – 25 70 – 30 80 – 2028

Ticket size, INR Cr Up to 200 Up to 400 100 – 250 at Up to 250 IREDA 500-1000 for PFC/ REC

Sources: Stakeholder Interactions and KPMG Analysis

Further, there is also lack of information on how risks are priced. It hence masks the opportunities to reduce the cost of debt. In the past, this has adversely impacted the success of guarantee based instruments owing to mismatch in guarantee facility pricing in comparison with the risk spread29 . 2.5.3.2 There are limitations in raising low cost funds through the bond market The cost of debt from conventional channels is still higher by ~1.5-2.5% as compared from bond market. Within the bond market, spread of 0.3-1.3% over 10 years government bond (risk free rate) exists, which can be narrowed by addressing some perceived risks of the sector.

Figure 11 Risk free rate and typcial borrowing cost of RE sector

12% 9.5% – 10.5% 8% – 9% 1.5-2.5%

8% ~0.3-1.3%

10.3% 4% 8.0% 7.69%

0% 10 Year Govt. Bond Coupon Rate- Conventional Channels Bond Issues - Banks, NBFCs

Source: SBI and RBI – Government Yield as on Feb 2018

28 On top up loans 29 Please refer to the study “Lesson Learning from ADB India Solar Power Generation Guarantee Facility Programme-conducted by KPMG for DFID”

Accelerated Deployment of Renewable Energy Sector RE sector has already seen initial round of issuances from RE players, e.g. Renew Power, NTPC and CLP. However, the quantum is still small and some of the intended investors like pension funds, insurance companies have shown limited interest. Moreover market is predominantly restricted to issuances rated AA and above as many sections of the investors (pension funds, insurance companies etc.) are restricted by regulations and/ or internal investment policies from investing in issuances rated less than AA. While several bond issuances have aimed to achieve such ratings through credit enhancements, the demand from institutional investors such as insurance funds has been weak for such structured products refer Figure 13.

A brief snapshot of Bond issuance in India – coupon rates vary across structured obligation Box 3 issuance and bonds with standalone ratings

Table 9 A brief snapshot of bond issuance by India corporates30

Entity Date Quantum Coupon rate Period Credit Rating

Yes Bank Feb-15 Rs 10 Bn 8.9% 10 yrs. AA+

Yes Bank Aug-15 Rs 3.15 Bn 9.0% 10 yrs. AA+

CLP Wind Farms* Sep-15 Rs 6 Bn 9.2% 2.6-4.6 yrs. AA

ReNew Power* Sep-15 Rs 4.5 Bn 9.8% 17.5 yrs. AA+

IREDA Jan-16 Rs 10 Bn 7.7% 10-20 yrs. AA+

Hero Future* Feb-16 Rs 3 Bn 10.8% Max. 6 yrs. -

NTPC Aug-16 Rs 20 Bn 7.5% 5 yrs. BBB31 -

30 Source – Secondary Research; coupon rates vary across structured obligation issuance and bonds with standalone ratings; * Structured Obligation 31 International credit rating

Accelerated Deployment of Renewable Energy Sector Figure 12 Credit Enhanced Bonds by ReNew Power

Indian Infrastructure Financing The guarantee was on ﬁrst loss basis (25%) Corporation Limited (IIFCL) and thereafter basis pari-pasu

Credit Enhancement Facility Overall bond rating improved 2% Guarantee from BBB to AA+ Fee

ReNew Power - Bonds for Solar Project in Maharashtra

Standard Bonds rated BBB

Ÿ ReNew was able to raise bonds at a coupon rate of 9.75% p.a. for a tenor of 18 years. Ÿ Renew bonds which were structured obligation rated were able to get better terms than conventional lending channels. However bonds with similar standalone ratings typically attack 8.75% to 9% Ÿ The issuance saw low participation from Institutional Investors - only Bajaj Insurance participated

2.5.3.3 Uncompetitive foreign borrowing due to hedging cost Foreign currency loans are typically provided by international banks, development banks, EXIM banks, etc. Such loans are generally at lower interest rates of 3 - 6% (Benchmark rate + 200-500 bps spread) for a tenure of 10 to 18 years. However, accessing international loans may not yield substantial cost reductions owing to the following:

Hedging Cost: The high hedging cost32 in India makes the cost of foreign borrowing comparable to domestic debt. For US Dollar, currently the cost of hedging is around 5-6%33 . The ﬁgure below highlights the landed cost of foreign borrowing and domestic debt.

32 To mitigate the currency exchange risk 33 Based on Industry interactions

Accelerated Deployment of Renewable Energy Sector Figure 13 Effective cost of foreign borrowing and domestic debt

12% 10.5%

8% 6.0% 10.5% 4% 3.0% Effective cost of debt, % 0% 1.5% ECB Domestic LIBOR Spread Hedging cost

Source - Primary Interactions, LIBOR as on September 2017

Typically, short term variations in exchange rate is signiﬁcantly higher than the long term movements of the same. Since, hedging instruments available in the India are typically of a shorter term, the same tend to be priced higher. The ﬁgure below shows the INR depreciation yearly and on seven years rolling basis with respect to USD.

Figure 14 Exchange rate, INR/ US$

High volatility in the short term; this risk may not be absorbed by individual companies but a larger diversiﬁed fund may be able to address the risk

Few instances when 40% depreciation has been higher than 5% CAGR 30%

20%

10%

A-96 A-97 A-98 A-99 A-00 A-01 A-02 A-03 A-04 A-05 A-06 A-07 A-08 A-09 A-10 A-11 A-12 A-13 A-14 A-15 -10%

-20%

Annual Depreciation 7 year rolling depreciation -30%

Note – A96 to A15 represents calendar years; data analyzed from 1995 to 2016; depreciation calculated based on daily exchange rate sourced from RBI Source – RBI and KPMG Analysis

Accelerated Deployment of Renewable Energy Sector As evident from the above graph, annual depreciation (blue line) shows that in short term the volatility is very high, hence shorter term hedging instruments are priced higher. However, if we look at 7 years rolling depreciation (blue dotted line) the volatility is low. While individual companies/ entities may not be able to manage the risk, particularly in the years when the volatility is higher, Governments or Sovereign funds with larger and diversified portfolio may be able to withstand the short term vagaries and be able to price hedging instruments in line with the long term trend. Risk spread: Another constraint with foreign currency borrowings is the risk perception of International investors. The spread by domestic lenders is in the range of 0.8 – 1.5% while the international lenders are pricing it in the range of 2.5 – 3.5%34 . The spread is driven by the risk perception which in turn is influenced by sovereign rating, sector rating, project rating etc. As confidence of international lenders and the RE sector improves, the spread will reduce bringing down the cost of the debt in India.

Box 4 Potential alternatives considered by Gov. to mitigate high hedging cost

Dollar denominated PPAs Ministry of New and Renewable Energy had floated the idea of dollar denominated PPAs. NTPC and PTC were identified as the nodal agencies for the same. However, it was finally not implemented due to the poor financial health of distribution utilities, and reservations by nodal agencies to take such exposure. In discussions with stakeholders, many believed, that dollar denominated PPAs is a good concept, however, making it available to all would be a challenge. Hence, project selection for such scheme can be made more stringent, e.g. projects only to be based on 100% FDI or projects above a certain size, etc.

Currency risk guarantee funds (Hedging facility) A currency risk guarantee fund can address high cost of hedging by covering the difference in exchange values between local and hard currencies over long term. Under this fund, distribution companies would quote their price for solar energy in foreign currency (USD) while locking up solar power for 25-year contracts and charging customers in Indian Rupees (INR). The idea is that the ministry would help create a (real) hedging fund with a corpus of INR 60 billion (approximately USD 1 billion) primarily by charging developers a hedging fee of INR 0.90/kWh (1.5 US cents/kWh) implying 6-7% in terms of rate of interest.

Source: IRENA

34 Industry Interactions

Accelerated Deployment of Renewable Energy Sector 2.5.4 Cost of equity On the equity side, the equity IRR expectation of strategic investors is typically between 14%-16% depending upon the nature of project. This implies a risk premium of approximately 7-8%, in comparison to the risk free rate i.e. 6-7%. The return expectations are typically higher for ﬁnancial investors such as private equity funds owing to the illiquid fund structure, management costs, lesser control, etc. Interventions which could address risk perceptions of investors, create monetization avenues could help in reducing the equity return expectations. The key viewpoints of stakeholders with regard to cost of capital have been captured below:

Box 5 Summary of the stakeholder responses

Ÿ Conventional lending channels: o While efforts to reduce cost of capital would be a welcome initiative, only a marginal reduction in cost of borrowings from banks can be achieved with reduction in risks for grid scale RE projects. o Banks may not have an appetite to pay fee for guarantee instruments. o Multilateral support to NBFCs could be explored for increasing their participation/ bringing down their cost of funds. Ÿ Bond markets: o In the past structured bond issues have managed to decrease borrowing rates by almost 100 bps compared with banking channels. However, ability to raise funds at lower costs depends upon the participation of low cost investor base such as insurance funds. The interest from such investors have typically been weak for credit enhanced bonds. o There is not much awareness and understanding with this segment of investors for the RE sectors which limits their ability to assess and price risks. o Innovations in bond market may yield higher rate reductions. However, this needs to be accompanied by extensive capacity building for the investor community. Instruments such as guarantees, if made available, need to be designed well to address the relevant risks and also be priced carefully. Ÿ Foreign debt: o Risk premium charged by international lenders is higher than domestic lenders. Fully hedged positions don’t bring much cost reduction vis-à-vis domestic debt. Interventions to bring down hedging cost need to be examined Ÿ Equity: o PE investors interest are skewed towards large established players o RE speciﬁc equity funds with multilateral support could be evaluated to increase ﬂow of equity at lower return expectations into this space.

Accelerated Deployment of Renewable Energy Sector Ÿ Other comments: Credit rating: Some stakeholders also raised concerns that given the country’s unique needs, a certiﬁcation standard should be tailored to the Indian context other than adopting international standards.

Key takeaway: Banking channels are operating on narrow spreads and have limited room for rate reduction. Innovations for reduction of cost of capital need to be explored in the bond, equity markets or for foreign currency loans.

Ÿ Strength of opinion, by stakeholder

Issue Description Lenders Developers PE/VC/IB

Debt Cost High Cost of Debt 89% 88% 33%

2.5.5 Limited monetization avenues Other than robust capital flows for greenfield projects, it is important to have depth in secondary markets to enable churn of the invested capital. On the debt side, NBFCs frequently down sell to commercial banks and other lenders in a bid to re-calibrate their exposure as well as recirculate their capital. On the equity side, there have been few cases of monetization in the sector. The sector has witnessed limited success in divestments through the financial markets. A public offer by Azure Power in New York Exchange and a yieldco by Sun Edison are a few examples of such exits. Other than these, there has been growing interest from strategic investors for project level as well as portfolio level acquisitions in the RE sector. The sector is also seeing traction in Infrastructure Investment Trusts (InvITs), which is a fairly new instrument in the Indian financial sector, and till date have been launched by only two entities, IRB (Roads sector) and Sterlite (Power Transmission sector)35 .

There is a clear need to create pathways for equity investors to invest as well as subsequently monetize their holding by leveraging public markets. This would require creating robust framework for innovative ﬁnancing avenues like REITs/ InvITs, Yieldcos. The key viewpoints of stakeholders with regard to monetization has been captured below:

34 These issues were oversubscribed by 1.35 (Sterlite) and 8.57 (IRB) times and saw participation of foreign institutional investors such as Deutsche Global Infrastructure Fund, Future Fund Board of Guardians managed by Rreef America LLC, Driehaus Emerging Markets Small Cap Growth Fund and Jupiter South Asia Investment Co. Ltd.

Accelerated Deployment of Renewable Energy Sector Box 6 Summary of the stakeholders repsonse

Stakeholder wise strength of opinion

Issue Description Lenders Developers PE/VC/IB

Issues with the Monetization 22% 38% 67% monetization

Monetization is clearly emerging as a key theme with PE funds which is the key segment that gets impacted the most deeply by the lack of liquidity. Hence, this also emerges as an important area of concern.

Accelerated Deployment of Renewable Energy Sector 3. Off-Grid/ DRE Segment 3. Off-Grid/ DRE36 Segment

3.1 Overview of off-grid/DRE Segment Since independence, India has made significant progress in terms of village electrification, with only 2,091 villages left to be electrified as on June 2017. However, the level of household electrification is still low, with close to 41 million rural households yet to be electrified in India as on October 201737. Of this population ~39 million households, are present in just 11 states as shown in figure below.

Figure 15 State wise un-electriﬁed rural households (as on 10 Oct 2017 base data)

20 75%

15 15 53% 56% 50% 49% 47% 10 40% 40% 7 25% 5 23% 20% 5 3 3 2 14% 2 2 Huseholds % un-electriﬁed 8% 1 1 2% 1 0 7%

No. Unelectrﬁed houselhods (Million) 0 0%

Un-electrifed Rural Households % Unelectriﬁed Rural Households

Source: ddugjy.gov.in (as on 31st August 2017

The problem of energy access assumes even more serious proportions if issues such as unreliability and inadequate supply are also considered. Even where consumers have access, service levels remain sub-standard in large parts of the country. Ailing discom health, high cost of delivery of electricity to villages, operational diculties of operating in remote areas, etc., affect the ability as well as the willingness of the incumbent utilities to adequately serve the needs of the consumers in rural areas. The central government has sought to address the problem of electricity provisioning through various programmes as summarized in the Table below. Some of the programmes, such as Distributed Decentralized Generation (DDG) scheme, Remote Village Electriﬁcation Programme, have also supported decentralized generation. However these have been excessively subsidy driven and have not been accompanied by a clear regulatory framework and institutional development, resulting in limited success.

36 Distributed renewable energy 37 Status as on 10th Oct 2017 (Base Data)

Accelerated Deployment of Renewable Energy Sector Table 10 Central government programmes supporting rural electriﬁcation

Scheme Target under the scheme Finance

Ownership Central Financial Assistance

Rural Village Electrification of Census VEC/ Community Ÿ 90% of the costs of Electrification villages and hamlets near various RE devices/ Programme electrified villages that are not systems subject to pre- (RVEP) likely to receive grid specified maximum connectivity subsidy

Deen Dayal Strengthening of sub- State discom Ÿ 60% grant from Upadhyaya Gram transmission and distribution government of India Jyoti Yojana38 system in rural areas Ÿ 30% loan from lenders (DDUGJY) Feeder separation into agriculture and non- agriculture

Distributed All un-electriﬁed revenue State government Ÿ 90% of the total project Decentralized villages and hamlets (above cost for capital cost Generation (DDG) population of 100) are eligible Ÿ Cost of spares39 for 5 Scheme under DDG scheme years after commissioning included as project cost

National Solar 20 million decentralised solar Local bodies/state Ÿ INR 90/Wp (with Mission (JNNSM) PV systems government battery storage) or 30 (Off Grid percent of the project component) cost

Saubhagya Electriﬁcation of all Discoms/State Ÿ 60% grant from households in rural and urban government government of India areas Ÿ 30% loan from lenders

Source: TERI40 , Ministry of Power, MNRE, DDUGJY.in

38 Erstwhile Rajiv Gandhi Grameen Vidyutikaran Yojana 39 Excluding cost of consumables and labour 40 GNESD. 2014 report, Renewable energy-based rural electriﬁcation: The Mini-Grid Experience from India. New Delhi: prepared by TERI

Accelerated Deployment of Renewable Energy Sector Recognizing the importance of encouraging private enterprise in the off-grid/ DRE power segment, the central as well as several state governments are increasingly seeking to promote investments especially in segments such as micro/ mini grid. With falling cost curves in technologies such as solar PV, solutions such as micro / mini-grids are generating signiﬁcant interest with stakeholders such as government, consumers, investors etc.

Micro/ mini grid solution is an attractive solution for energy access issue owing to its ability to mimic the virtue of the central grid by catering to productive as well as aspirational use of electricity while overcoming other issues related to the grid such as transmission bottlenecks, etc. Mini-grids also have the technical capability to interconnect with the grid and can potentially integrate with the state utility as a last mile service provider. However, such solutions have failed to scale up owing to multiple barriers including the key risk perceived by investors of business discontinuity on eventual arrival of the grid.

While these are signiﬁcant initiatives towards increasing private sector participation in this space, other risks and challenges that impede commercial ﬁnance availability need to be understood and duly addressed to enable a rapid scale up. There are myriad barriers to accessing capital and these include aspects such as asymmetric information, lack of institutional capacity, high off-taker risk, small ticket size, lack of collaterals, regulatory risks, etc. Resultantly, off-grid energy (“OGE”) players have so far largely depended on grants/ low cost funding support from DFIs, Government, impact investors, etc. for meeting their capital needs.

3.1.1 Mini-grids/ DRE systems Functionality Mini-grids have the ability to cater to consumers’ aspirational requirements for life enhancing appliances such as television, refrigeration and allowing access to revolutionary technologies such as ATM, internet, or increasing productive business activities. The ﬁgure below shows a schematic layout of a DRE system.

Figure 16 Mini-grids/ DRE systems layout and typical business model

Mini-grid system Business Models Energy Source

1 EPC Only Households Anchor load Ÿ Gram Oorja Solar Wind Ÿ Minda Nextgentech Ÿ OMC

Biomass Hydro 2 EPC + developer Distribution Network

Ÿ Mera Gao Power Ÿ Husk Power Battery Ÿ Banks DESI Power

Accelerated Deployment of Renewable Energy Sector Key drivers The key drivers for this segment are the increased capacity of the rural consumer to pay as well as the need to move up the energy ladder. Policies at national and state level have been formulated which could lead to an increase in setting up of mini grids in the country.

Business models Of the different ownership models in the DRE segment, most enterprises adopt the “build only” model. Two broad different ownership categories for DRE classiﬁcation are as follows:

Figure 17 DRE business models

Ÿ The company installs a plant and transfers ownership to a third party EPC Model (village community, government, local entrepreneur, NGO etc.) and might provide some maintenance and after-sales support. E.g. Gram Oorja

Ÿ The company installs the plant and employs its own staff to operate it and Resco Model collect payments from the end consumer. E.g. Mera Gao Power

Source: KPMG analysis

Most players are opting to operate in remote/ off- grid areas where the risk of the grid arrival is less and set up small AC or DC micro grid to cater to the needs of small loads. However, there are players such as OMC which are increasingly seeking to establish large mini–grid projects in areas which are connected to the grid but remain underserved. Drawbacks o The investment required for setting up a mini grid is signiﬁcantly high

o There should be a high density of households and presence of productive loads for mini- grids to be commercially feasible o These have a long gestation and hence face signiﬁcant regulatory risks such as risks of grid arrival. Further, grid interconnection is still untested

Accelerated Deployment of Renewable Energy Sector 3.2 Stakeholders perceptions on predominant risks in DRE segment Through desktop research and understanding of the off-grid RE sector, key challenges were identiﬁed, and were discussed with stakeholders to understand their viewpoints on the same. Basis these themes and discussions with stakeholders following viewpoints emerged:

Figure 18 Stakeholders’ viewpoints at a glance – Overall Scenario

70% High transaction cost 14% 40% Off take risk 71% 30% Lack of Business model/ history 36% 30% Policy risk 43% 30% Lack of project evaluation expertise 57%

0% 10% 20% 30% 40% 50% 60% 70% 80%

Percentage of respondents

Financers Developers/EPC

Source: Stakeholder consultation

3.2.1.1 High transaction cost and small investments For commercial lenders, transaction size and cost is also a key consideration. Capital cost of a mini-grid of 50 kW system will have a capex of around ~INR 6.5 – 7.5 Million. Assuming a leverage of 70%, the debt component shall be close to ~INR 4.5 – 5.3 Million. For a commercial lender, the transaction costs (project appraisal, monitoring & control) remain largely unchanged with size of lending thereby increasing the cost of debt.

3.2.1.2 Lack of payment security mechanism One of the key issue highlighted by investors is the lack of payment security mechanism. Unlike grid system where payment against power consumption is assured by a PPA (for the generator), in the case of off-grid system, there is no such assurance. The agreement between the developer and individual consumers is backed by mutual trust and there is limited scope of legal action for any recovery (though developers have rated such risk as low). The greater manifestation of such risk is in the scenario when grid extends to such region. With no proper policy framework in place, revenue generation of off-grid systems can be materially impacted and thereby undermining their ability to secure funds.

Accelerated Deployment of Renewable Energy Sector 3.2.1.3 Policy uncertainty with regard to grid extension resists lenders from funding off-grid projects Uncertainty with regard to future grid extension has emerged as one of the major concerns for stakeholders as it is expected to impact the future cash ﬂows. While in the last 2 years, there have been policies and regulations issued by states such as UP, Bihar, Madhya Pradesh and Jammu and Kashmir apart from a draft national policy, the implementation of these is a concerns amongst the ﬁnanciers.

An illustration of losses incurred on account of grid extension is shown below.

The capital expenditure in a typical mini-grid system consists of costs associated with generation (panels, inverters, battery etc.) and network costs (cables, network etc.). The levelised tariff for a typical 30-50 kW system with a life of 25 years works out to be INR ~20/kWh as illustrated below:

Table 11 Levelised tariif for an MGO

Details Year Unit Number Key Assumptions

Levelised generation cost FY 2017-18 (INR/kWh) 10.42 Mini-grid size: 50 kW (operating (including manpower for 365 days); Project life: 25 yrs; collections, generation Generation capex cost: INR 24.5 lakhs; O&M, etc) Storage capex cost: INR 12 lakhs; Network capex cost: INR 9 lakh; Levelised storage cost (for FY 2017-18 (INR/kWh) 4.28 Debt equity 60:40, interest of 12% operation during nightime) PLF 17%, 15% losses O&M Cost: Levelised network cost FY 2017-18 (INR/kWh) 6.27 • 2 personnel for operations (INR/kWh) (including and network per village @ technical manpower, Rs10000 per month O&M, etc) • 1 supervisor per 4-5 villages • Rs 40000 per annum additional O&M expenses Levelised cost of supply of FY 2017-18 (INR/kWh) 20.96 Escalation at 6% power if MGO supplies • Rs 40000 per annum (INR) additional O&M expenses Escalation at 6%

Accelerated Deployment of Renewable Energy Sector In such a scenario, even if discom takes over the network asset and compensate the developers for generation related costs in form of a FiT (Which currently in couple of states is proposed as the solar rooftop FiT), the developer would incur losses. The above scenario occurs since the FiT at the time of system takeover could be lower to ~INR 10/kWh (actual levelised tariff for mini-grid generation project). Hence, a clarity in terms of FiT pay-out at the time of grid interconnection needed to be provided at the beginning of the project. Mini-grid regulations in most states recommend paying of the book value of the network cost to the mini-grid operators in case of takeover by discom. Even if book value of the asset is offered to the to the mini-grid operator, there will a net loss in terms of cost recovery since this doesn’t cover the opportunity cost of the investment. Further, the tariff levied to the end consumers was on levelised basis and there would have under recovery in terms of actual cost and revenue realized. 3.2.1.4 Customer payment mechanism One of the key issues that prevents rural consumers in India from making a purchase is lack of substantial and consistent household income. According to the Socio Economic and Caste Census (SECC) data, 74.5% of rural households have an income of the highest earning member below INR 5,000 per month. Only 8.3% of rural households have an income of the highest earning member above INR 10,000 per month.

While most of the off-grid companies initiated their businesses with a perception that the consumers would not default on payments if the need of electricity is well catered, the scenario has been different in various cases. Companies such as DESI Power, NatureTech Infra, and Minda Nexgentech have failed to sustain their business models and operate under self-equity investments. Over a period of time these companies have adopted CSR driven funding model where the margins are captured upfront. Key challenges faced by these enterprises in terms of payment security are listed below:

Ÿ Uncertainty of revenue from consumer - Currently there is limited formal evidence regarding therevenue collection from end customers/ rural users even though informal mechanisms exist. While 3- 6 months of payment taken as advance security deposit from rural customers ensures revenue visibility for the Energy Services Company (ESCO), there is a limitation in terms of lack of contractual obligations. Consumers tend to shift to low cost electricity once the grid reach the village and hence the revenues of the ESCOs are curtailed to a large extent. The price arbitrage that can be offered by discoms is on account of government subsides which an ESCO may not access to do. Further most consumers in rural emerging markets do not have credit history and in case a consumer does default on their loan/ monthly fee payments, the ﬁnancing institution/ company likely has no way to singlehandedly track down the individual and demand payment Ÿ Lack of minimal revenues assurance - The availability of institutional Power Purchase Agreements (PPAs) with an anchor client in rural areas is low and only few companies like OMC Power have been able to tap that.

Accelerated Deployment of Renewable Energy Sector Ÿ Policy disruption to tariff is presently an unaddressed risk - Mechanisms to be grid interactive and feed back to the central grid once it arrives in the region of plant operation can help address this risk. Long pay- back period-long pay back periods due to high initial investment and lack of ability to earn very high returns Ÿ Lack of willingness to pay upfront - Rural consumers are service conscious and hence are reluctant to payment for the electricity cost upfront. Only models where consumers have opted to pay upfront (in form of monthly pre-paid fees) is under the pay-as you go model where the ownership transfer is guaranteed. Ÿ Scepticism about the company - Not only will consumers be less aware of many off-grid companies, they will also have less innate trust in new companies because of their lack of access to information and because of the plethora of fake and poor-quality brands being offered in the marketplace. Off-grid enterprises are exploring new payment collection models; however most still collect payments through ﬁeld collection agents such as Mera Gao Power. Besides ﬁeld collections, some off-grid enterprises like NatureTech Infra and OMC have started using mobile payment systems and players such as Simpa Networks are adopting Pay as You Go model. Though Indian off-grid enterprises are aware of different payment collection models, scepticism and capacity constraints such as lack of working capital and access to mobile commerce technology prevent most from trying them. The Reserve Bank of India (RBI) requires all mobile transactions to be linked to a formal bank account. In rural areas, many poor households do not have bank accounts, making mobile payments challenging. Such regulations have historically made it dicult for mobile payment systems to gain traction in India.

3.2.1.5 Delay in subsidy payment adversely impacting the return There have been a number of challenges in implementing subsidies to encourage investment in the off-grid energy space. Applications for such subsidies require a large amount of paperwork and must go through several layers of bureaucracy before they are approved. Even then, subsidies are often delayed or not disbursed at all to implementing banks. The delay in subsidy disbursement leads to increase in working capital requirements and thus impacting the tariffs and overall project returns.

3.3 Future ﬁnancing pre-requisites Amongst the currently existing off grid solutions, three different systems suitable in the Indian context are the solar home systems, micro grid and a larger mini grid system. A top down analysis conducted showed the market potential for these systems in India and is summarized in the ﬁgure below. It is estimated that on a conservative basis, a total investment of ~INR 164 billion would be needed, to electrify ~10 million households through off-grid solutions in India.

Accelerated Deployment of Renewable Energy Sector Figure 19 Assessment of market potential for Off-grid sector in India

Investment Potential (INR Billion) Installation Potential (MW) 3,214 700 657 3500 490 600 147 3000

500 2500 1,090

400 2000 353 254 1,689

MW 327 300 98 1500 INR billion 545 200 1000 164 127 763 1,634 49 256 163 100 500 817 63 128 272 0 51 0 327 Conservative Moderate Aggressive Conservative Moderate Aggressive Scenario Scenario

Mini-Grid Micro-Grid Solar Home System Total Mini-Grid Micro-Grid Solar Home System Total

Source: KPMG Analysis

A recent study conducted by the Climate Group estimated that the installed mini-grid capacity is likely to reach ~90 MW by 2019 and ~330 MW by 2022. This is in largely in line with the conservative scenario presented in the figure above. Thus far, the Government of India has relied mainly on grid extension projects for providing electricity access. Under Rajiv Gandhi Grameen Vidyutikaran Yojana (RGGVY) programme, now Deen Dayal Upadhyaya Gram Jyoti Yojana (DDUGJY), in the last two years, a total of INR 11 billion have been released, mostly for grid expansion projects to un-electrified villages. However, there are constraints with electricity supply even with grid extension. One major issue is ability and willingness to supply on the part of the distribution companies (discoms). Most state-owned discoms are suffering huge losses. Given the problem of low electricity rates in rural areas and higher ATC losses, Discoms are reluctant to supply power to such areas. Assuming that the discom network is present and the demand represented by unelectrified households is met by discoms even with provision of a basic minimum of 1 unit/household per day, the subsidy burden can potentially increase by ~ INR 2,000 cr (assuming that there is existing network and rural42 marginal cost of supply is INR 10/ unit and with current tariff which is at INR 2.5/ unit for rural BPL consumers). In reality, subsidy is likely to be higher owing to factors such as low collection eciency, incremental costs for grid extension, manpower deployment, etc.

42 Cost of supply to rural areas is typically signiﬁcantly higher than overall average owing to cost of network extension/ strengthening, long network across different voltage levels with signiﬁcant losses, high O& M costs and lower network utilization resulting in higher per unit costs

Accelerated Deployment of Renewable Energy Sector The business model can be better implemented by private sector as these can charge market driven tariff considering these are not market regulated and are better placed to provide electricity locally to village because of limited requirement of transmission network, better ability to manage the load, lower gestation period and good reach in the local community helping in increased collection eciency.

3.3.1 Potential business models 3.3.1.1 Likely evolution of the sector It is likely that going forward, the sector sees a co-existence of the following models of delivery:

Ÿ Delivery by discoms: In areas where grid supply is reliable there may not be a case for off-grid systems;

Ÿ Independent off-grid systems: These systems are likely to exist in scenarios where the rural areasbeing served are remote and which are unlikely to be connected with the grid;

Ÿ Co-existence models, where mini-grid and other off grid systems co-exist with discoms: Co- existence models are emerging as a central theme in effective delivery of electricity to rural areas and development of implementable, scalable models are likely to provide directional impetus to sector initiatives. 3.3.1.2 Potential business model

1) Independent Mini-Grid Model

2,821 villages have been identified for electrification through decentralized distributed generation (DDG) due to limited scale and/or distance (from grid) and/or terrain (e.g. hilly). Out of these 2,821 villages, 398 villages have been electrified through distributed generation while the remaining 2,351 are yet to be electrified10 . State wise distribution of village to be electrified under DDG scheme is as under:

Figure 20 Un-electriﬁed villages to be covered under DDG scheme

1000

750

475 500 394 330

No. of villages 250 106 69 42 23

0 AP As Jh Ch Od MP Bi Other

Others include Uttrakhand (15), Rajasthan (4) and Karnataka (4). AP stands for Arunachal Pradesh Source: GARV Website

10 Work might be initiated in some of these villages. However details are not available in the public domain.

Accelerated Deployment of Renewable Energy Sector For the 2,351 balance villages yet to be electriﬁed under the DDG scheme, mini-grids with their inherent advantage in terms of scalability, can be a potential solution. The mini-grids could be allowed to run independently. However, the model may have to be tweaked to bring structure and standardization and to also make it amenable for commercial lending.

Figure 21 Independent mini-grid model

Viability Gap Funding (VGF) State Nodal Mini-Grid Agency Operator

Installation+ Power Supply+ Tariff O&M+ Billing + Collection

Consumer

Mini-Grid operator: Operator shall be responsible for energy generation, storage, setting up the distribution network, supplying power, maintaining the network, O&M, billing and collection. State Nodal Agency : Will provide viability gap funding through the grant of subsidy while facilitating registration of project in the state. Some of the key challenges which would need to be addressed under this model are discussed below: Ÿ There has to be an effective subsidy disbursal mechanism to allow such mini-grids to be viable and also reduce the cost of electricity for the consumers; Ÿ Access to finance at competitive terms can be a challenge owing to small size and high risks perceived. Problems are compounded owing to lack of awareness of financiers. Targeted capacity building of financiers as well as policy efforts to create scale, for e.g., through bundling of such areas, could be some of the initiatives which need to be explored.

Ÿ Effective community involvement is needed to ensure ease of operations, lower default risks, etc. This would require initiatives such as capacity building and awareness programmes for communities.

2) Co-existence business models In order to evolve potentially workable business models which allow co-existence of the grid with mini-grid operators/ local operators, it is important at the outset to identify the areas of competencies for government agencies and private players.

Accelerated Deployment of Renewable Energy Sector Figure 22 Competency mapping of various agencies across the rural value chain

Economic Village level Agency Power Transmission End consumer Network O&M Billing and Procurement distribution distribution collection

Government Strong Strong Moderate Moderate Inadequate Inadequate

Private Inadequate Inadequate Inadequate Moderate Strong Strong

Respective competencies in power procurement and transmission can change materially with scale of business. 3) Co-existence Model 1 – Storage backed Revenue based Model The central government is targeting 100% household electriﬁcation by 2019. However, grid supply to rural areas has challenges in terms of cost of delivery both on account of high cost of power during peak hours as well as high technical and commercial losses.

In view of above, it is pertinent to reconsider the discom model and explore possibilities where private entities can bring in eciencies through local operations, thereby making such discom supply viable. In such a scenario, discoms still have signiﬁcant role to play in terms of centralized procurement and supply of power, however, the business models will undergo a signiﬁcant change to ensure, 1) reliability of supply of power, and 2) more ecient local operations designed to reduce losses.

The following table provides an illustrative framework on how potentially these issues can be addressed:

Table 12 Issues and possible solution for rural electriﬁcation

Issue Solution

High cost of power and reliability during Local operator/ agent to procure power from the peak hours grid and deploy localized storage solutions to increase reliability of supply

High AT&C losses in rural areas Local operator/ agent to be responsible for O&M and collection work in return of fees

Accelerated Deployment of Renewable Energy Sector A setup is required wherein the responsibility for supply is split between the discom and a local operator, each operating as per their strengths. The responsibility will be shared as below: a. Discom: Responsible for setting up the distribution network to connect the households, ensuring power procurement and supply. b. Storage Operator: Responsible for setting up the local storage network and enhancing reliability of power supply. c. Revenue Agent: Responsible for network O&M, billing and collection

Figure 23 Storage backed revenue based model

Maintenance and Collection Fees Discom Power Supply* Tariff Viability Gap Funding Collected Storage-Power State Nodal (VGF) Storage Network provision+ Agency Purchase Cost Revenue Agent Operator Power Supply Storage Supply**

Billing+collection Consumer * During off-peak hours Regulator determined tariff ** During peak hours

It is possible that there are alternate scenarios where the discom, the storage operator and the revenue agent are not different entities and some of these activities are performed by a single entity. However, such models will evolve. Some of the key challenges which would need to be addressed under this model are discussed below: Ÿ Determining the economics for alternate options which ensure that most effective mode of delivery is chosen while keeping in view the future cost curves; Ÿ The mechanism for determining compensation to the provided to the storage operator to ensure that adequate returns are available to the operator; Ÿ Training and capacity building of stakeholders with respect to storage based business models; Ÿ Providing scale and effective utilization of storage capacities to the storage operators. Here aspects such as bundling requirements of areas in close proximity to each other need to be explored.

Accelerated Deployment of Renewable Energy Sector 4) Co-existence Model 2 – Build Operate Transfer (Optional) (BOT-o) model for Mini-grids Grid extension to all the households is targeted by 2019. Till 2019 (or till few years later in case of delay), there is an option of electrification through setting up of mini-grid network which will operate on a BOT-o model with the discom. The mini-grid operator will be responsible for setting up the system including the generation, network, power supply, O&M, billing and collection. The mini-grid operator will be identified through appropriately defined mechanisms.

Mini-grid operators enters into a strategic tie up with discom for connecting the un- Figure 24 electriﬁed areas

Through an appropriately Strategic tie up for deﬁned mechanism BOT-o State Nodal Mini-Grid Agency Operator Discom System sale

Power Supply+ Tariff O&M+ Billing and Collection

Consumer

Post grid extension, following are the various possible arrangements: a. Discom takes over the entire mini-grid system (Discom owned model) The discom pays for the entire cost of the system and takes over the responsibility of supplying to the end consumers. In effect the mini-grid operator will sell the entire system at a pre- determined price mechanism and moves out of the business. The tariff for the end consumers will be the regulator determined tariff.

Figure 25 BOT-o, Post grid extension: Discom owned model

Through an appropriately deﬁned mechanism Cost of system State Nodal Mini-Grid Agency Operator Discom System sale

Tariff

Power Supply+ O&M+ Consumer Billing and Collection

Accelerated Deployment of Renewable Energy Sector b. Discom takes over the mini-grid but O&M, Billing and Collection is managed by mini-grid operator as a franchisee The discom pays for the entire cost of the system and takes over the responsibility of supplying to the end consumers. However, the mini-grid operator will continue to manage O&M and billing & collection for the system and in turn, will be paid management fee by the discom. Effectively, mini-grid operator will be the service provider to discom aiming to leverage the local presence and know-how. The tariff for the end consumers will be the regulator determined tariff.

Figure 26 BOT-o, Post grid extension: Discom owned – Mini-Grid Operator managed model

Cost of system Through an appropriately + deﬁned mechanism Management Fees State Nodal Mini-Grid Agency Operator Discom System sale

O&M+Billing + Tariff Collection Power Supply

Consumer

c. Mini-grid continues to operate independently but sources power from Discom (Discom supply model) The mini-grid operator will continue to operate and supply in the area of operation. However in this case, the discom will connect to the mini-grid system to ensure security of supply. The mini-grid operator can thus remove the storage13 43 and reduce its cost of supply and provide power seamlessly with the grid.

43 Depending on the discoms reliability of supply and the state pea

Accelerated Deployment of Renewable Energy Sector Figure 27 BOT-o, Post grid extension: Discom coverage model

Through an appropriately deﬁned mechanism Tariff State Nodal Mini-Grid Agency Operator Discom Power Sale Power Supply+ Tariff O&M+ Billing and Collection

Consumer

This model promotes market based model where MGO sets up mini-grid in any area where he sees the opportunity. Tariff is not regulated and the MGO determines tariff in negotiation with its consumers. The discom is mandatorily required to connect if the MGO opts for interconnection. The independent MGO can also sell their network to the discom and sell their entire power to the grid. Such MGOs supplying full power to the grid can be considered akin to distributed generation sources of the discom. Some of the key challenges which would need to be addressed under this model are discussed below: Ÿ Mechanism for selection of mini-grid operator and determination of tariff for the end consumers Ÿ Mechanism for coordination between discoms and mini-grid operators and ensuing that the SLAs are clearly defined and adhered to Ÿ Determining the framework based on which the Post grid extension arrangement will be determined and the compensation mechanisms for the mini-grid operator The model to be adopted post grid extension will depend on the conditions in the area of supply. This will be given as a pre-condition to the mini-grid operator at the time of bidding. Further terms of tariff determination, conditions for selection of a particular model and methodology for asset price determination will need to be decided based on consultations with the various stakeholders before the bidding. Thus overall there will be optimal utilization of capabilities of various agencies and assurance of reliable power supply to all the entire households. 3.4 Challenges in financing for Off-grid RE The off-grid electricity segment in India, though has significant potential but has not been able to scale up. This has been the case due to various financing and rest of the ecosystem related challenges.

Accelerated Deployment of Renewable Energy Sector Accordingly, in order to evolve instruments which could catalyse low cost capital into the off-grid RE segment, extensive stakeholder discussions were conducted to analyze the current and expected ﬁnancing gaps for the off-grid RE segment in India as below: Ÿ Financing gaps for the off-grid RE segment in India Ÿ Key sector risks which need to be addressed to ensure that adequate capital is available at low cost to support the rapid scale up of the off-grid RE segment The stakeholders identiﬁed for the consultations covered all categories/strata as indicated in the table below:

Table 13 Category wise number of stakeholders consulted

Number of Type of stakeholder Sub-categories stakeholders contacted

Financiers Commercial Banks 2

Donors 1

NBFCs 3

Crowd Funder 1

International Financial Institutions 2

Private Equity/Venture Capital 1

EPC model 7 Developer EPC + Developer 6

Assemblers/ Distributer 1

Total 24

Also includes those developers/ ﬁnanciers that though not present in the sector have evaluated the sector

3.4.1 Financing gap Capital has been identified as one of the principle barriers for the industry’s further development. Based on the stakeholder consultation undertaken, the investment side barriers such as insucient knowledge of lenders, lack of innovative deal/fund structures and better investment opportunities in other industries hampers the flow of funds in the off-grid space. Although the effort to improve the overall financing environment in the off-grid sector would depend on how well the above challenges are mitigated, some of the investment side barriers can be mitigated through enhanced funding to priority sector. RBI mandates lending of 40 percent of ‘Adjusted Net Bank Credit’ or ‘Credit Equivalent Amount’ of off-balance sheet exposure, whichever is higher, towards priority sector by all

Accelerated Deployment of Renewable Energy Sector scheduled commercial banks operating in India. Current exposure of banks towards Priority Sector Lending (PSL) is ~INR 24,000 Billion44 which constitutes 33% of the overall credit exposure of commercial banks. In order to reach the target speciﬁed under the RBI guidelines of 40% credit exposure to priority sectors, an additional ~INR 4,800 Billion needs to be lent. Even if 50% of the incremental lending requirement is done in the off-grid electriﬁcation space, ~2,000 MW of off-grid capacity can be installed electrifying ~20 Million households45 .

Figure 28 Lending potential to off-grid under PSL

80000

70000 Scope for off- 60000 24224 29052 grid: 2.4 GW 2414 50000 4828

40000 72631 30000 33% 40% INR Billion of bank of bank 20000 credit credit

10000

0 Total Bank Current Targetted Extra credit 50% of Credit bank exposure exposure to be lent credit to be to PSL to PSL lent

Source: RBI, KPMG Analysis

While few lenders such as RBL, ADB, OPIC have started lending to the sector, the investments have come only when enterprises have achieved signiﬁcant scale. RBL has used the USAID Partial Credit Risk Guarantee facility to structure a deal with OMC that operates on an anchor load model and has payment guarantees from telecom operators. ADB and OPIC have funded companies like Simpa Networks that has reached a signiﬁcant scale of operations, have proven track record and better payment guarantee structure through pre-paid metering. Regional Rural Banks (RRBs) and Micro-Finance Institutions (MFIs) may be better suited to lend to the off- grid sector. These institutions are mandated to lend to the rural population. These RRBs and MFIs have the experience to lend to the rural population since the credit history, experience with individuals and social will are best known to them. Currently a few MFIs or RRBs are lending to the off-grid sector.

44 RBI Data for Deployment of Gross Bank Credit by Major Sectors Updated as on 25th November 2016 45 considering INR 1 Million debt for 10 kw system and a 100 households being catered through 10 kw system

Accelerated Deployment of Renewable Energy Sector Table 14 Few MFIs funding in off-grid sector

MFIs/ RRBs Geography Sources of Funds

Mahashakti Foundation Odisha SIDBI, FWWB, NABARD, KIVA, SBI, Milaap, Arc (MSF) Finance

Bhartiya Samruddhi Finance Pan India Bhartiya Samruddhi Investments and Consulting Ltd. Services (BASICS Ltd.)

Saija Bihar SIDBI, Accion, Pragati India Fund

Sarala West Bengal Vijaya Bank, Indian Overseas Bank, Union Bank of India, Reliance Capital, Reliance Finance Ltd. Religare, SBI, IDBI bank, MAS Financial Services

SV Creditline Pvt Ltd. UP, MP and PNB, IDBI, SIDBI, Canara Bank, HDFC, RBL, Axis (SVCL) Rajasthan Bank, IFMR Capital, OIKO Credit, SBI

Swayamshree Micro Credit Odisha SBI, Rashtriya Mahila Kosh, SIDBI, NABARD, IDBI, Services (SMCS) Indian Bank, Canara Bank

Rashtriya Gramin Vikas Assam IFCI, IDBI, NABARD, Social Welfare Trust Nidhi (RGVN)

SEVA Manipur BASIX, FWWB, NABARD, North Eastern Development Finance Corporation Ltd., Tata Trusts

Aryavrat Gramin Bank Uttar Pradesh Bank of India

Manipur Rural Bank Manipur United Bank of India

Bangiyo Gramin Vikas Bank West Bengal United Bank of India

Ujjivan Financial Services Pan India IDBI, Axis Bank, HDFC, ICICI, Yes Bank, IndusInd Bank, IFMR Capital, NABARD, Edelweiss Capital

Allahabad UP Gramin Bank Uttar Pradesh Allahabad Bank

Prathama Bank Uttar Pradesh Syndicate Bank

Source: Industry Reports, Stakeholder Consultations

Accelerated Deployment of Renewable Energy Sector The responses received from the various stakeholders with regard to the availability of capital are as below:

Box 6 Summary of the stakeholder responses with respect to availability of capital

Unsuitable terms: Ÿ Commercial banks are not willing to lend below 16%-18% interest rate and have higher tenors. Ÿ VC debt funds charge higher premium because of the initial risk exposure. Lack of secondary market: Banks do not recognize the off-grid projects as infrastructure projects. They believe that the assets are not bankable i.e. there is no secondary market in existence for buying off-grid assets currently. Need for patient capital: Typical horizon for private equity is 4 to 5 years. However mini-grid sector is at a nascent stage and may need patient capital to allow it to scale up as the sector matures. Accessing CSR funds: CSR funds focus more on social, health and gender related areas of development. While there is some CSR fund being allocated to the off-grid DRE space, a greater awareness and scale up is required.

Accelerated Deployment of Renewable Energy Sector 4. Identifying ﬁnancial instruments 4. Identifying ﬁnancial instruments

4.1 Emerging Priorities Based on the industry and financing overview in grid RE and DRE/ off-grid sector the key financing themes/ priorities which have emerged are discussed in this section. The key priorities emerging from the stakeholder discussions and secondary research are important in terms for improving access to financing and increasing uptake of renewable energy in both grid and off-grid sector. These themes will be act as directional inputs for recommending/designing new financial instruments. The figure below summarizes the emerging priorities for both grid and off-grid sector.

Figure 29 Immediate priorites emerging for scaling RE growth in sub sectors

Ÿ Reduce cost of capital by targeting cheaper Access to Cheap Grid & Off sources of capital and/ or introducing risk capital Grid mitigation measures Ÿ Framework to help the poor states RE scale up Grid & Off achieve scale in RE deployment along off- in poor states Grid grid RE wherever economical

Wider investor Ÿ Frameworks to enable participation from Grid participation large Institution Investors Key theme Ÿ Help banks and developers reﬁnance Reﬁnancing through Bonds markets or other avenues Grid

Enable Ÿ Create avenues for monetization of equity Grid monetization investments in RE

Ÿ Access to cheap capital: Availability of debt may be a constraint for new and small developers though it is unlikely to be an issue for good projects/ established developers. Thus deepening the capital pool with introduction of risk mitigation structures will be important to reduce the cost of capital. In DGG/ off-grid sector access to capital or ﬁnance is itself is a challenge due to un-tested commercial viability of models, poor and uncertain regulatory framework and lack of payment security mechanism.

Accelerated Deployment of Renewable Energy Sector Ÿ RE scale up for poor states: The states such as Bihar, Jharkhand, Odisha, UP, etc. have been clearly lagging behind in their efforts to integrate clean energy and achieve 100% electrification, possibly constrained by factors such as Discom finances and high risk perception with investors, etc. It is important to develop a plan to include some of the poorer states which have RE potential but have not seen much of development. Ÿ Wider investor participation: Conventional lending channels are operating on narrow spreads and have limited room for rate reduction and also are nearing their sectorial exposure limits. The other potential avenue to lending channel is bond markets, but in India, the bonds market lacks depth. Hence, involvement to wider invertors is curial to increase the capital pool. Ÿ Refinancing: Lenders are nearing sectorial limits. There may be financing gap in achieving the targeted RE capacity addition if issues such as power sector NPAs are not resolved or growth in overall credit of the banking sector is below expectations. Also many large developers have reached their banks’ exposure limits. In such a scenario, it is important to deepen the pool of capital available for new projects and facilitate refinancing of existing debt to create capacity with existing lenders and developers. Ÿ Enable Monetization: Monetization is clearly emerging as a key theme with PE funds which is the key segment that gets impacted the most deeply by the lack of liquidity. Hence, this also emerges as an important area of concern. Thus, sector needs new platforms/avenues for equity monetization, for creating a broad based growth in the sector. The key themes emerge as the foundation to design financial instruments. A larger set of financial instruments were evaluated based on a detailed matrix (discussed in subsequent sections) and few instruments were shortlisted for adoption with MFI/IFI interventions to make them more scalable and effective. 4.2 Identified financial instruments for evaluation

The ﬁnancial instruments identiﬁed for evaluation are enumerated below. These instruments have been evaluated in current form (without any MFI interventions).

Table 15 Identiﬁed ﬁnancial instruments for evaluation

Sl. No. Financing instrument Sector focus Key features /Description

1. Mezzanine ﬁnance Grid RE Mezzanine capital is cheaper than cost of equity and costlier than cost of debt. 2. Masala & Green Bonds Grid RE Fixed income ﬁnancial instrument for raising capital through debt capital market – proceeds from bond can only be used in climate aligned projects and Masala bonds are de-risked from currency volatility.

Accelerated Deployment of Renewable Energy Sector Sl. No. Financing instrument Sector focus Key features /Description

3. Infrastructure Grid RE InviTs are structures are similar to Yielcos. This investment trusts instrument helps in monetization of operational (InvITs) assets, by offering its units to investors through Trusts.

4. Infrastructure Debt Grid RE Increases the debt pool for RE projects. Lower cost Fund (IDFs) due to better credit rating.

5. Project Structuring (e.g Grid RE Creating project pipelines by creating framework to Rewa Solar project) debottleneck capital ﬂow in poor states.

6. Renewable energy Grid RE RE platforms stimulate renewable energy deal flow platform and engage Institutional investors in financing RE projects though Bond Issuance, Securitization and Refinancing.

7. Pooled sector speciﬁc Grid RE Sector speciﬁc fund of funds are fairly common in funds (Funds of Fund) Europe and are funded through pool of funds from varied investor’s e.g. budgetary funds, Development banks and Private Investors.

8. Hedging facilities Grid RE Exchange rate hedging facility to de-risk the exchange volatility.

9. Concessional credit lines DRE & Off-grid Pre-approved concessional loans for speciﬁc RE sector.

10. Partial credit guarantees DRE & Off-grid Credit guarantees for payment default and other RE risks.

11. Direct investments DRE & Off-grid - (Equity Investment from RE MFI/IFI)

Accelerated Deployment of Renewable Energy Sector 4.3 Evaluation matrix for financial instruments All the identified financial instruments are evaluated on two aspects – Effectiveness and Scalability. 4.3.1 Effectiveness The financial instruments were evaluated on multiple parameters to access the effectiveness of the instruments. The parameters are described below: Ÿ Degree of issue resolution: This ranks the financial instruments based on the current issues it addresses. The issues/ need identified, based on the output of earlier modules, are access to cheap capital, refinancing and securitization. Ÿ Market Acceptability: This parameter ranks the financial instruments based on their ability to scale the growth of the sector. Ÿ Ease of Implementation: The parameter ranks the financial instruments based on the likely time taken from inception to implementation. The implementation period inherently include the regulatory issues.

The weightage and the scale of each parameters for Grid RE are provided in the ﬁgure below:

Figure 30 Effectivness index’s parameters and ranks for Grid RE

Weightage Parameter Parameter Deﬁnition Effectiveness Scale

1 2 3 Degree of issue Current sectorial issues Cheap capital Cheap capital Cheap capital 40% Resolution it resolves Reﬁnancing Reﬁnancing Monetization

40% Market Scaling up sector Instruments for Instruments for Instruments Acceptability growth thought capital initial Growth broad based to scale markets and tailored of Sector growth of sector investments structures

20% Ease of Potential time from >1Yr. 1Yr. <1Yr. Implementation inception to mplementation

1 Poor 2 Average 3 Good

The weightage and the scale of each parameters for DRE/Off-grid RE are provided in the ﬁgure below:

Accelerated Deployment of Renewable Energy Sector Weightage Parameter Parameter Deﬁnition Effectiveness Scale

1 2 3 Degree of issue Current sectorial issues Access to Access to commercial 40% Resolution it resolves Grants subsidized capital capital

20% Ease of Potential time from >1Yr. 1Yr. <1Yr. Implementation inception to mplementation

1 Poor 2 Average 3 Good

4.3.2 Scalability The scalability measures if such instrument will find wider acceptance and snowball in to a key source of finance for RE developers with limited intervention and/ or support. The financial instruments were evaluated on multiple parameters to access the scalability. The parameters are described below: Ÿ Standardization: This parameter ranks the instrument based on the repeatability of the instrument. More standard an instrument is, easier is to replicate and thus provide scale to investments. For instance, bond issuance are easy to replicate given standard procedures and processes. Ÿ Aggregation: This parameters ranks the instruments based on the scale it provides due to aggregation of assets. The structures such as InvITs where aggregation of assets enable large issuance thus increases scale in the investments. Ÿ Liquidity: This parameters rank the instrument based on how liquid they are. Liquidity has always remain a key aspect for the investors. Thus more liquid instruments tend to have more investor attraction e.g. bonds and InvITs. Ÿ Mainstream financing: The parameters rank the instrument based on how it increase the scale of market and enables wider investor base and makes investments more mainstream. For instance, bonds, InvITs, RE Platforms enables participation of wider investors through participation in wider markets (Primary market, Secondary markets).

Accelerated Deployment of Renewable Energy Sector Figure 31 Scalability Index’s parameters and ranks for Grid and Off-grid RE

Weightage Parameter Deﬁne Scalability Scale

1 2 3 Standardizaton Replicability of Difference process Similar process 25% instrument case to case across all categories of assets

25% Aggregarion Provides scale through One transaction One transaction aggregation of assets one asset multiple asset

25% Liquidity Liquidity the instrument Less liquid More Liquid provides Easier to exit

25% Mainstream Wider markets and Limits wider Enables Wider Financing investor participation investor Investors participation participation

1 Poor 2 Average 3 Good

4.3.3 Evaluation matrix The instruments were evaluated on the Effectiveness and Scalability index and were ranked on all the parameters. The ﬁgure below depicts the inferences of the evaluation matrix. The instruments evaluated here are being compared relatively, and in individual capacity the instruments will still be useful for the broad based growth in the sector.

Figure 32 Evaluation Matrix for instruments

‘Evaluate for off-grid & Grid Evaluate if MFI RE’ can add value

High Intervention required to improve effectiveness ‘Clear Go for Grid RE’ Instruments can be made more effective and are mainstream suitable for mature sector like gird RE sector ‘Evaluate for off-grid’ Med Low in effectiveness-suited Scalability Index for sector in initial growth stage Low Low Med High Effectiveness Index

Accelerated Deployment of Renewable Energy Sector Ÿ ‘No-Go’: The financial instruments with limited effectiveness and scalability. May not considered be evaluate further. Ÿ ‘Evaluate’: The financial instruments, though ranked low in effectiveness index, are scalable. To be evaluated to identify the interventions are required to improve the effectiveness. Ÿ ‘Clear Go ’: The instruments which are effective and have potential of scalability, may be considered for adoption. A subset within the category is instruments with high effectiveness and scalability. Such instruments may find acceptance independent of the intervention by multilaterals/ development banks. Instead, for such instruments, it is to be evaluated if multilaterals/ development banks can add further value. The financial instruments were evaluated along the two aspects (and on each underlying parameter) and the result is depicted in the following figure.

Figure 33 Relative ranking of ﬁnancial instrument for Grid RE sector46

RE Platforms High InvIts Bonds More mainstream IDFs ﬁnancing suitable for grid RE Pooled Heading1 Funds

Moderate Intervention required to facilities make them mote ecient

Potential Scalability Project Mezzanine Direct Structuring Credit Lines Finance Investment Low Low Med High

Current Effectiveness

Figure 34 Relative ranking of ﬁnancial instrument for DRE/ Off- grid RE sector

High

Partial Credit Guarantee Intervention required to

Moderate make them mote ecient Direct Concessional Potential Scalability Investment Credit Lines Low Low Med High Current Effectiveness

46 Hedging has not been considered for further evaluation as its being covered by India Innovation Lab for green ﬁnance

Accelerated Deployment of Renewable Energy Sector Instruments which falls in the ‘Clear Go for Grid RE and Off-Grid RE category are further evaluated to see what interventions MFI/ IFI can bring in to make these instruments more effective and scalable. A brief snapshot of new/adopted instruments along with interventions from Multilateral Financial Institutions (MFI) interventions to make the more scalable and ecient are also discussed in the ﬁgure below:

Table 16 New/ Adapted ﬁnancial instruments

MFI/IFI Role to make instrument Instrument Description of current issue Subsector more effective/ scalable

Credit Enhanced Ÿ Masala bond issuance till Ÿ Credit enhancement of masala Grid RE Masala Bonds date is limited to large bonds by risk mitigation corporate houses with structures such as providing signiﬁcant scale of partial credit guarantee or operations through subscribing to Ÿ Bond issuance by medium subordinate tranche of bonds and small RE players is Ÿ Credit enhanced can enable limited otherwise due to Masala bond issuance by RE low credit rating players, which are limited otherwise due to low credit rating

Third Party RE Ÿ Larger developers with Ÿ Acting as a sponsor (or backing Grid RE InvITs diversiﬁed portfolio launch a sponsor) can be critical in InvITs on their own, smaller driving investors' conﬁdence developers may not have and participation in such trusts. the desired scale to set up Ÿ MFI/IFI support can be elicited an InvIT for accessing for launching InvITs which can capital markets. provide platform for Ÿ Smaller developers typically medium/smaller scale RE face constraints in seeking players monetization or fresh capital raise for new projects.

Accelerated Deployment of Renewable Energy Sector MFI/IFI Role to make instrument Instrument Description of current issue Subsector more effective/ scalable

MFI sponsored Ÿ IDFs are constrained by Ÿ Credit enhancement of masala Grid RE Renewable their relatively lower capital bonds by risk mitigation IDF base which in turn limits the structures such as providing exposure to individual partial credit guarantee or borrower and the impact it through subscribing to can create. subordinate tranche of bonds Ÿ IDFs are one of the Ÿ Credit enhanced can enable potential reﬁnancing Masala bond issuance by RE vehicles and renewable players, which are limited energy dedicated otherwise due to low credit infrastructure fund can help rating create a large pool of funds which would deepen the lending market by increasing funds in circulation with NBFCs and banks.

RE & Associated Ÿ Majority of the funds are Ÿ REAT to invest in PE funds Grid RE Technology focussed at larger focused on RE and associate (REAT) fund of infrastructure sector or are technologies or partner with RE funds focused for larger regions funds to attract relevant group than speciﬁc country. of investors ensuring the Hence RE projects have to alignment of return compete with other infra expectations and investment sub-sectors and other proﬁle. countries. Ÿ MFI can be a sponsor as an anchor partner and taking the equity risk in the fund.

Accelerated Deployment of Renewable Energy Sector MFI/IFI Role to make instrument Instrument Description of current issue Subsector more effective/ scalable

Project Ÿ “Hybrid Investment Model” Ÿ MFI investing in solar park Grid RE Structuring for is variation of the model infrastructure e.g. Transmission poor states adopted in REWA solar evacuation etc. MFI may charge (Hybrid Annuity park. In addition to risks infrastructure charges in Model) mitigation measures in (INR/kWh) over the period of Rewa, this structure also 10-15 years, this will reduce the aims to develop the RE park cost of developers as infrastructure to enable infrastructure charges will not increased private be charged upfront. investments in the poor states.

Partial Credit Ÿ Partial credit guarantee Ÿ As MFI/IFI have relatively low DRE/Off guarantee facility will partially share cost of fund it will enable grid RE the credit risks with the reasonable cost of guarantee commercial lenders. The fees and would enable access to facility will enable limited commercial loans at reasonable recourse debt ﬁnancing terms. available to DRE segment on reasonable terms and conditions.

The above new/adopted instruments were discussed in details with all the stakeholders such as Developers, Lenders, Multilaterals, Merchant bankers and Institution investors etc. After several round of discussions with stakeholders, three ﬁnancial instruments were shortlisted for implementation and further structuring. The three adopted ﬁnancial instruments which are shortlisted for implementation are discussed in the subsequent sections in details. Out of the three instruments one is for off-grid sector and two for grid RE sector.

Accelerated Deployment of Renewable Energy Sector 5. Shortlisted ﬁnancial instruments 5. Shortlisted ﬁnancial instruments 5.1 Credit enhanced Masala Bonds

5.1.1 Background

Masala bonds are Indian Rupee denominated bonds issued in international capital markets. In the recent past, IFC47 and NTPC48 have issued Masala bonds at London Stock Exchange. IFC (rated S&P AAA, August 2015) raised bonds at a coupon rate of 6.45% and NTPC49 (rated S&B BBB-, August 2016) at 7.48%. Cumulatively, the two corporates have issued Masala bonds worth USD 6 Bn. Masala bonds is attracting significant interests from the power developers as this instrument enables the developers to, 1) access international capital, 2) reduce cost of debt by accessing foreign loans with no hedging requirement, and 3) reducing exposure with Indian lenders. Masala Bonds are also gaining acceptance with a wide section of investors such as Institutional Investors. However, the limitations of the bond issues are as follows: 1 These are limited to large corporate entities with strong balance sheet and large operations (offering a diversified portfolio), which have the ability to issue bonds with relatively higher credit ratings. On the other hand, renewable energy (RE) players with relatively modest operations and financial strength, in spite of future business potential, have failed to participate in the Masala bond market. The reasons being relatively lower track record of operations and lower credit ratings of RE projects. 2 The regulatory guidelines from RBI with respect to issuance of masala bonds (as it under the ambit of External Commercial borrowings) have prescribed all-in cost ceilings as well as maturity based on amount being raised. This further restricts the flexibility of the borrower to tap different investor base as well as restricts participation of relatively smaller players. Given the above context, with the aim to enable a wider participation, a modified instrument namely, ‘Credit Enhanced Green Masala Bond’ is suggested as a potential alternative for RE players to raise low cost funds.

5.1.2 Instrument description and USP In the suggested model, a masala bond issue is credit enhanced through an MFI/ IFI50 (“MFI”) support. The credit enhancement can be achieved either through creating tranches (of the bonds issue) wherein subordinate loan tranche may be subscribed by MFI or through partial credit guarantees provided by the MFI.

47 International Finance Corporation 48 NTPC Limited is India’s largest energy conglomerate with the total installed capacity of 51,410 MW (including JVs) with 20 coal based, 7 gas based stations, 1 Hydro based station and 1 Wind based station. The company targets non-fossil fuel based generation capacity to reach nearly 30% of its portfolio by 2032. 49 NTPC is AAA entity in India 50 Multilateral Financial Institutions/ International Financial Institutions

Accelerated Deployment of Renewable Energy Sector It is expected that with MFIs providing credit enhancement, masala bonds issued by developers even with relatively moderate portfolios shall also be able to access international capital at competitive rates, provided the all- in costs, with guarantee fee do not breach the ECB ceiling limits. With ﬁnancing cost as one of the major cost components of RE projects, wider access to cheaper capital can go a long way in accelerating growth of RE in India.

Masala bonds can play a key role in:

- Increased sources of debt capital for projects - Wider foreign investor participation - Freeing up bank exposures - Reduce the cost of borrowing as commercial banks and NBFCs have limited margin to reduce the cost of debt (spread for such ﬁnancial institutions is limited to 1.25% – 2%). 5.1.3 Suggested instrument structure for credit enhancements Potential ways in which MFI can support Masala bond issuance are:

Credit enhancement through superior/ sub-ordinate security structure (tranching) where senior tranches can be subscribed by the large institutional investors and junior tranches by a MFI. This structure has capability to improve the risk coverage available for the senior bond holders, through structured waterfall and escrow arrangements as well as putting in place various covenants. Participation by a reputed MFI being like an anchor investor widens the reach of the issue. Partial Credit Guarantees for Masala bond. Partial credit guarantees can improve the credit ratings of the bond thereby widening the investor pool who are looking at high safety credit exposures. Such guarantees by a MFI/ IFI may particularly go a long way in improving the acceptance of such issue from Indian borrowers.

Figure 35 Proposed structure of MFI backed masala Bond

Credit enhanced Masala bonds (Credit Guarantee) Creating credit enhancement by superior/ sub-ordinate security structure (tranching)

Bond Market Investors Bond Markets Investors DFI/IFI

Subscribed by Investors Senior Tranches (AAA) Junior Tranches (AA) Raises low cost funds subscribed by Pension Fund Subscribed by IFI/MFI

Credit enhancement of Raises low cost funds SPV Issuer Issue through Credit Credit enhancement guarantee SPV Issuer through Tranching Proceeds to be used for Proceeds to be used for development of RE Portfolio development of RE Portfolio

RE Project 1 RE Project 2 RE Project 1 RE Project 2

RE Project 3 RE Project 4 RE Project 3 RE Project 4

RE project portfolio RE project portfolio

Accelerated Deployment of Renewable Energy Sector As per the RBI regulations on issuance of rupee denominated bonds overseas, following are the applicable rules:

Ÿ Maturity period: Masala bonds up to $50 million should have maturity period of 3 years while the bonds raised above $50 million equivalent to rupees should have 5 years of maturity period per ﬁnancial year.

Ÿ The all-in-cost ceiling: As per norms, the all-in-cost ceiling will be 300 basis points over the prevailing yield of government securities of corresponding maturity. As of June’17, the G-sec yield for 3 years is at 6.5%, 5 years at 6.7% and10 years at 6.75%.

5.1.4 Prior examples and experiences in credit enhancement

Project Bond Initiative The ‘Project Bond Initiative’ is a joint initiative by European Commission and European Investment Bank (EIB). It was created by European Investment Bank (EIB) in contribution of budgetary fund from European Union51 . The initiative allowed EIB to provide credit enhancement for project bonds issued by companies undertaking eligible infrastructure projects. Credit enhancement was provided through subordination of low tranched debt portion which boosted the credit rating of the project bonds to a level that allows institutional investors to invest. This subordinated tranche is provided in the form of a Project Bonds Credit Enhancement (PBCE); which has a limit of 20% of the total project value. EIB provided this enhancement in two forms - unfunded and funded PBCE Ÿ EIB provided a loan from the outset (funded PBCE), which means that less debt capital has to be raised from private investors. Ÿ EIB provided a contingent credit line for an already fully ﬁnanced project (unfunded PBCE). This could be drawn upon, for example, if there is an overrun in construction costs or if the income from the infrastructure project is temporarily insucient to service the subordinated debt of the private investors (interest and repayment. The risk-sharing arrangement between the European Commission and the EIB, as well as the EU contribution, was crucial to develop and implement the initiative. It allowed EIB to target riskier, larger transactions and to widen the investor base. The total costs of projects supported from EU budget amounted to EUR 4,270 million. The initiative resulted multiplier effect (computed as the ratio between the total projects costs divided by the aggregate amount of the EU contribution) is 18.652 . Thus such platforms have helped in achieving leverage for development funds and create signiﬁcant impact in deploying private capital.

51 EIB funded Euro 750 Mn and EU’s budgetary support was Euro 230 Mn (ﬁrst loss basis) 52 Project Bond Initiative assessment report 2015-16

Accelerated Deployment of Renewable Energy Sector ADB India Solar Power Generation Guarantee Facility Programme

In India, a partial credit guarantee (backed by DFID), called the ADB solar guarantee scheme, was offered to financial intermediaries by ADB. However, this had limited success. One of the key reasons identified for lack of participation by financial intermediaries in the ADB Solar credit guarantee scheme was high guarantee costs. The key reasons for limited success of this facility are presented in the box below:

ADB India Solar Power Generation Guarantee Facility Programme

As per a study done by KPMG as documented in the paper ”Lessons from ADB India solar power generation guarantee facility programme“, key lessons learnt for limited success of the ADB programme were: Ÿ No first loss provision: The guarantee amount that could be claimed by the lenders was on pari-passu basis and not on first loss basis. Therefore, if there were defaults in scheduled payments, the lender, even after availing the Facility, faced the risk of the loan being declared as a non-performing asset. Ÿ Conversion of loan into foreign currency loan on default: The conversion of INR to USD denominated loan on default attracted exchange management issues. Ÿ Cost of guarantee a critical factor in determining the uptake of any guarantee facility. A deeper understanding needs to be developed regarding the extent of guarantee fees that lenders would be willing to bear so that adequate margins are available to them, which in turn requires an understanding of how and which risks are priced by lenders. However, there is lack of transparency in this regard which makes the exercise dicult. Ÿ The eligibility criteria should be simplified to enable higher participation in the facility. The number of procedures to avail the facility and the time required to complete these procedure should be kept to the minimum. Ÿ Time to market and relevance: Given the rapidly evolving nature of the solar sector, the time to market for any product needs to be shortened considerably. Further, any product designed should aim to follow the market in terms of market requirements.

5.1.5 Role and value addition from MFI

Involvement of an MFI/ IFI with masala bonds issued by relatively medium to small RE developers but with investment grade projects, will be crucial to increase the traction from overseas institutional investors as this would lend a tangible (through risk mitigation structures) as well as intangible (by virtue of association) credibility

Accelerated Deployment of Renewable Energy Sector to such issuances. The experience gained by overseas investors through the initial risk mitigated structures can help in increasing their awareness and understanding of the Indian RE sector and enable them to invest subsequently independent of such risk mitigation structures.

Such structure will also enable leverage to donor funds - the amount of private investment that can be mobilized per dollar of MFI funds. 5.1.6 Possible structure for the ﬁnancial product

Table 17 Possible structure for ﬁnancial instrument

Key Parameters Descriptions

Sub-sector focus Ÿ Grid RE

Preferred route to provide Ÿ Preferred risk mitigation structure is to provide credit enhancement to credit enhancement bond issuance is through Partial credit guarantees (PCG) to small and medium size RE players. Ÿ A Guarantor would be required to extend PCGs to developers

Role of Guarantor Ÿ Extend PCG to medium and small RE players for bond issuance

Selection process for Ÿ Willingness and ability to make ﬁnancial commitments in Grid RE Guarantor

DfID Role in PCG Ÿ Work to design, develop and launch PCG in cooperation with Guarantor Ÿ Promote showcase pilot projects for financial assistance under this facility Selection and approval of Ÿ Portfolio quality and compliance with DfID eligibility requirements projects Ÿ First level ¡ Ticket size - to be based to enable financing for medium & small size RE players ¡ The minimum stand-alone credit rating of the project / Proposed bond issue to be credit enhanced should be at least ‘BB’ ¡ The infrastructure project should have achieved COD / provisional COD ¡ 85% of capacity under PPA requirements Ÿ Second Level: Due diligence – keeping in view the regulations and DfID/ intermediary rules. For instance, creditworthiness of sponsor; commercial review of EPC warranties and performance guarantees; credit profile of module provider, arrangement for sale of power etc. Ÿ There can be relaxation for projects in ‘poor states’

Accelerated Deployment of Renewable Energy Sector Key Parameters Descriptions

Key design Ÿ Credit enhancement of masala bond issuance by way of unconditional element & Term and irrevocable partial credit guarantee to enhance the credit rating of and condition the proposed bonds. Ÿ The minimum tenure of the project bonds to be 5 years with or without a lock-in. However, the complete repayment of the bond issue should be scheduled to happen within 85% of the economic life of the project. Ÿ Extend partial credit guarantee to the extent of 20% of Total Project Cost (up to 40% of Total Project Cost with a backstop guarantor/ risk sharing partner) Ÿ Extent of guarantee / credit enhancement extended shall be limited to the extent which enhances the credit rating of the project bonds to its desired credit rating (minimum AA rating) subject to a maximum of 50% of the total amount of Project Bonds issued. Ÿ Intermediary may enter into risk sharing agreements with DfID / other ﬁnancial institutions in respect of any Guarantee/ credit enhancement extended/ to be extended by intermediary. Ÿ Risk sharing arrangements could be in the form of a guarantee, reinsurance, back stop guarantee, unfunded risk participation or any other agreements which is intended to reduce/ cover/ share the risk of intermediary.

Reporting and Ÿ Intermediaries will be required to continuously monitor the Monitoring performance of the project loans and submit quarterly reports to DfID/ investment committee and other related entities.

5.1.7 Implementation pathway

The masala bond and credit guarantees structures are long being used in the ﬁnancial sector and to that extent, implementation is not expected to be a challenge. In the present case, the implementation pathway will be relevant from the perspective of framework to select the Developer, Investment Bankers and cost of risk mitigation, and will be done in close consultation with Development Bank or MFI, subject to the regulatory frameworks. The implementation pathway will be detailed once the stakeholder consultation are done for the ﬁnancial instrument proposed. However, a broad plan as DfID moves towards implementation phase is as follows:

Accelerated Deployment of Renewable Energy Sector Sl. No. Implementation pathway

1 Stakeholder consultations for the instruments (merchant bankers, MFIs, developers, overseas investors, ﬁnancial institutions, regulators & legal institutions)

2 Suggest structures for risk mitigation. Understand costs and other considerations from MFI and subject to regulatory limits.

3 Development of a pipeline of developers interested in Credit Enhanced Masala Bonds.

4 Framework to select the intermediaries such as merchant bankers, credit rating agency, underwriters, trustees etc. Discussion/road shows with probable investors.

5 Finalization of the instrument structure in discussion with MFI and merchant bankers, and the government.

6 Roll out

5.2 Partial credit guarantee facility 5.2.1 Background

Distributed renewable energy (DRE) sector in India, has seen limited funding sources and commercial capital has largely not been available to the players/ projects. Subsidies from the government and grants from trusts, foundations and CSR funds have been an important source of financing. Donors such as development institutions are now exploring enabling capital such as guarantee schemes in order to encourage commercial lenders to lend this space. Credit guarantees have been successful to bring in commercial lenders where, there is lack of precedence and experience of lenders. 5.2.2 Instrument description and USP The ‘Partial credit guarantee’ facility will partially share the credit risks with the commercial lenders. The facility will enable limited recourse debt financing available on reasonable terms and conditions. The facility will partially cover any default of scheduled repayments of principal and accrued interest on first loss basis. While commercial debt is largely unavailable to the sector, even where this is available, interest rate could be as high as 17-18%. In such a scenario, it is assumed that even after paying the fee for the guarantee instrument. 5.2.3 Business case for instrument Availability of debt at competitive rates is still a challenge for the DRE segment. Most lenders prefer lending to sectors with established business models, known performance characteristics, and quantifiable risks. Hence, there are very few commercial lenders who have extended finance to this segment and the terms have been mostly stringent in terms of cost and tenure.

Accelerated Deployment of Renewable Energy Sector Commercial banks in India typically do not lend to DRE/ Off-grid owing to high risks perceived in lending to this sector. This makes it dicult for the new companies to obtain ﬁnancing on reasonable terms without high collateralization. With DRE projects being relatively small and having various risks of lack of payment security mechanism etc. cannot be easily mitigated.

Support from development institutions/ charitable organizations in the form of grants, credit lines, guarantees, etc. have encouraged some lenders to extend low cost loans. However, there has been limited scale up in such lending.

This facility will help in twin objectives:

(a) Incentivizing commercial lenders to lend to DRE segment by risk sharing (b) Making limited recourse debt ﬁnancing available to DRE segment at reasonable terms.

5.2.4 Proposed structure and its beneﬁt

The proposed structure for the PCG is presented in the ﬁgure below:

Figure 36 Proposed structure for PCG

Developer in DRE segmant Multilaterals/IFI Take over of defaulted

loan Loan Repayment disbursement

Commercial bank Partial Credit Guarantee

Funds released in case of default

Accelerated Deployment of Renewable Energy Sector 5.2.5 Value addition from MFI/IFI

MFIs/ IFIs can help in access to debt ﬁnancing at cheaper terms by providing PCG facility to DRE developers through intermediaries. 5.2.6 Possible structure for ﬁnancial product

Table 18 Possible structure of ﬁnancial product

Key Parameters Descriptions

Sub-sector focus Ÿ DRE/ Off-grid sector

Preferred route to set up a Ÿ To partner with intermediaries/ commercial lenders PCG facility Ÿ NBFCs, National Banks which have mandate to invest in DRE segment Ÿ Some of the lenders recommended are IREDA, REC, NABARD, and Rural/cooperative banks/ Micro-Finance institute

Selection process for Ÿ Willingness and ability to make ﬁnancial commitments in Grid RE Intermediary Ÿ Existing scale of operations in off-grid RE Ÿ Intermediary with investment grade rating

Role of Intermediary Ÿ Lend to DRE/Off-grid RE on reasonable cost Ÿ Appraisal of projects to be eligible for the facility Ÿ Intermediary to be responsible for utilization of this facility

DfID Role in PCG Ÿ Work to design, develop and launch PCG facility in partnership with other entities such as ﬁnancial institutions and intermediaries Ÿ To create an investment committee for the implement the facility

Selection and approval of Ÿ Process to be simpliﬁed and non-cumbersome projects for PCG facility Ÿ A third party (promotional body e.g. renewable energy development authority in each state) may be involved to make the process faster by pre-approving the projects to be eligible. Eligibility criteria to be decided by investment committee of facility as provided below : o First level: Meeting eligibility criteria (Minimum capacity, Business models involved, required minimum experience in DRE) o Second Level: Due diligence – keeping in view the regulations and DfID/co-ﬁnancing party disbursement rules. E.g. creditworthiness of sponsor; commercial review of EPC warranties & performance guarantees.

Accelerated Deployment of Renewable Energy Sector Key Parameters Descriptions

Key design element & Term Ÿ Guarantee to be on First loss basis and condition Ÿ Tenor of the guarantee equivalent to risk its covering and ﬂexibility to address transformational change in sector and its associated impact on market requirement Ÿ Tenor: Tenor of the partial credit guarantee needs to be closely tied with the risk it aims to address. Limited exposure to projects of same corporate

Reporting and Monitoring Ÿ Intermediaries will be required to continuously monitor the performance of the project loans and submit quarterly reports to DfID/investment committee and other related entities. Ÿ Portfolio quality and compliance with DfID eligibility requirements

5.2.7 Implementation pathway

The broad plan for implementation pathway for the ﬁnancial instrument proposed is as follows:

Sl. No. Implementation pathway

1 Stakeholder consultations for the instruments (DRE/ offgrid players, MNRE, lenders/ micro lending institutions, state nodal agencies, regulators)

2 Finalization of Development Bank/ MFI/ IFI and understand costs and other considerations from MFI

3 Framework to select the stakeholders and Selecting the intermediaries and bringing them onboard

4 Finalizing the legal structure of transactions subject to regulatory limits

5 Roll out

Accelerated Deployment of Renewable Energy Sector 5.3 Renewable energy infrastructure debt fund 5.3.1 Background

In the recent past, Indian renewable sector has seen accelerated growth in the capacity addition (19% CAGR FY 2012-17) and related investments. A significant proportion of such capital has been financed by the commercial banks in India. It is estimated that between FY 2017–2022, investments to the tune of USD 9553 Bn is required in the RE sector which is nearly three (3) times the investments till date. Even assuming some delays, it is estimated that USD 69 Bn would be required to support a capacity addition of 14054 GW by FY2022. As a result, some banks are nearing exposure limits55 , at individual borrowers’ level and/ or Groups’ level. Also, some banks/ NBFCs might have restrictions with respect to Assets Liability Mismatch (ALM) issues. Therefore, bigger developers stand a chance to face constraints with respect to availing adequate loan funding. The role of alternate debt financing in such context becomes crucial, particularly as the capital requirement is likely to continue to increase y-o-y in view of the steep capacity addition targets. In such a scenario, it is important to deepen the pool of capital available for new projects as well as facilitate refinancing of existing debt to create capacity with existing lenders. Infrastructure Debt Funds (IDFs) are one of the potential refinancing vehicles. Key advantage being relatively lower cost of funds and access to Institutional Investors. There have been three IDFs (NBC-route) in India till date – L&T IDF, India Infradebt (ICICI Group promoted?) and IDFC IDF. The three IDFs have grown their asset base from around 600 crore about two years ago to over 9,000 crore in the current fiscal56 , indicating increasing market acceptance of IDFs. However, the three IDFs are constrained by their relatively lower capital base which in turn limits the exposure to individual borrower and the impact it can create. Thus, with an aim to enable refinancing through scaling IDFs, the MFIs/ IFIs57 (“MFI”) sponsored IDF focused on RE assets or called ‘’Renewable energy focused infrastructure Debt Fund’’ (RIDF) has been suggested. 5.3.2 Instrument description and USP Typically, IDFs raise equity capital from Sponsors, and debt from both foreign and domestic investors through bond issuance in capital markets. In the suggested structure, i.e. RIDF, MFI shall subscribe to long term equity (subject to be applicable regulatory norms). It is envisaged that a MFI playing the role of anchor sponsor, shall be able to attract cheaper and long term equity capital. Corresponding leverage (debt borrowings through capital market) shall enable scale to the structure. With potential leverage of 4 – 10 (times the equity investment), Green IDFs can create significant impact for MFI on rupee to rupee basis.

53 RE inclusive of Solar, Wind, Small Hydro and Bio Power estimated based on the base year FY 2016 54 Based on primary interactions capacity additions of Wind and Solar rooftop has been moderated by 15 and 20 GW respectively by FY 2022 55 with respect to outstanding exposure 56 http://www.thehindubusinessline.com/money-and-banking/infra-debt-funds-gaining-more-investors-projects/article9608557.ece 57 Multilateral Financing Institutions/ International Financing Institutions

Accelerated Deployment of Renewable Energy Sector 5.3.3 Business case for the instrument

Annual capital requirement for the power sector in the period FY 2017-2022 is estimated to be ~USD 35-40 Bn, as against the historical average of USD 20-25 Bn for last five years, considering the Government’s RE targets. The incremental capital requirement is primarily on account of steep RE targets. On the other hand, as discussed above, banks are nearing their sectorial limits. Hence, refinancing existing debt exposure of Indian commercial banks, will create headroom for banks and NBFCs to lend to fresh projects as well as free up banking limits for developers who could use the lending capacity for the Greenfield projects. The other aspect of RIDF which shall make it apt for RE sector: Ÿ Lower cost of capital: IDFs are mandated to invest only in operational assets. Additionally, due to the portfolio diversification, the credit rating of the IDF is typically higher than individual RE projects (typically rated in low investment grade bands). The above two factors reduce the cost of capital for IDFs in comparison to banks. For RE focused IDFs also similarly cost of capital can be sought to be lower. By keeping a certain minimum amount for other infrastructure projects, diversification benefits can also be sought to be achieved. For instance, bank loans to RE sector is typically priced at 10.75% - 11%, which can be reduced to 9.75% - 10% through GDFs. Ÿ Access to broader investor’s base: improved credit rating, driven due to MFI backing, will enable larger participation from long-term investors such as pension and provident funds thereby widening the pool of available capital. Ÿ Access to investors looking for “green” investment avenues: The GDFs focused on RE assets can provide access to investors specifically looking for investments in renewable energy. The Fund can potentially reduce the cost of debt to RE projects by 0.75% – 1%, which in turn can lead to reduction in the tariff by INR 0.17-0.20 per unit (on levelized basis). 5.3.4 Current IDF Structure

The key entities in an IDF are: Ÿ Sponsor: is the entity floating the NBFC/ Trust (which in turn floats the fund). It is required to maintain equity share within 30% - 49% for the term of IDF. Ÿ Foreign Debt Investors: International investors which can invest in the IDFs notes issuance. Ÿ Institutional Investors: Domestic investors which can invest in the IDFs notes issuance. Ÿ Project Portfolio includes operational projects with minimum one year of successful operations. Ÿ Exposure Limits: The maximum exposure that an IDF-NBFC can take on individual project is 50% of its total capital (Tier I and Tier II)58 . An additional exposure up to 10% could be taken at the discretion of the board of the IDF-NBFC. RBI may, permit additional exposure up to 15% (over 60%) on being satisfied that the financial position of the IDF-NBFC is satisfactory, subject to such conditions as it may deem fit to impose regarding additional prudential safeguards .

58 Tier 1 capital consist of shareholder’s equity and retained earnings; Tier 2 is supplementary capital which includes revaluation reserves, hybrid capital instruments and subordinated term debt

Accelerated Deployment of Renewable Energy Sector Ÿ Tax Beneﬁts: To attract funds, an exemption from income tax for IDF has been provided. To attract off-shore investors withholding tax has been reduced from 20% to 5% on the interest payment on the borrowings of IDFs.

The current IDF structure is presented below:

Figure 37 Current Structure of IDF

Debt Investors Insurance Funds Pension Funds Foreign Currency Bonds

OVERSEAS Fund

Rupee Fund Institution Sponsor IDF Rupee Bond Investors Repayment Rupee Fund

INDIA Project 1 Project 2 Project 3 Project 4

Source : INFRADEBT, ﬁrst IDF in India

5.3.5 Proposed structure and its beneﬁts

The RIDF may be able to attract large investors and also scale up the IDFs considerably. The potentials ways are: Ÿ MFI can be the sponsors in the 'RIDF' and increase its capital base, thus making it more scalable. It will also improve its international credit rating and thus the cost of funds; and/ or Ÿ MFI can help 'RIDF' raise funds in the international market by assisting in concept implementation and road shows with their overseas investor's network. Ÿ MFIs can also help the “RIDF” raise funds through using innovative routes such as masala bonds.

Accelerated Deployment of Renewable Energy Sector Figure 38 Investments from MFI

Institution Institution Investors Investors Masala

OVERSEAS INR Foreign Currency Bonds OVERSEAS Bonds Fund Funds MFI/IFI Credit Masala enhencement Bonds Rupee Fund Sponsor+ Institution Sponsor Institution MFI RIDF Investors RIDF Investors Improve credit rating Rupee Bond Rupee Bond Broaden Equity base Lower coupon rate Repayment Rupee Fund Repayment Rupee Fund

INDIA Project 1 Project 2 INDIA Project 1 Project 2 Project Portfolio Project Portfolio

5.3.6 Value addition from MFI/ IFI

MFI, with their relatively lower cost of fund and long term investment horizon, can create relatively larger RIDF which may not be otherwise feasible at the level of individual entities. MFI can also attract institutional investors which are hereto not present and hence, widen the pool of capital. 5.3.7 Possible structure for ﬁnancial product

Table 19 Possible structure for ﬁnancial product

Key Parameters Descriptions

Sub-sector focus Ÿ Grid RE

Preferred route to set RIDF Ÿ DfID to co-opt with eligible ﬁnancial institution Ÿ NBFC route is preferred as sponsors is readily available

Selection process to select Ÿ Grid RE co-partner

Accelerated Deployment of Renewable Energy Sector Key Parameters Descriptions

Preferred route to set RIDF Ÿ Private or Government NBFC as per the regulations only these can set up a IDF Ÿ Willingness and ability to make financial commitments in Grid RE Ÿ Existing scale of operations in grid RE Ÿ Intermediary with investment grade rating Role of Co-Partner Ÿ To be co-sponsor the RIDF Ÿ Primarily responsible to implement the RIDF and find projects to consume the same hence be the partner cum implementation Ÿ Promote showcase pilot projects for financial assistance under RIDF DfId Role in RIDF Ÿ Work to design, develop and launch RIDF Ÿ To recommend and find co-sponsor for creating RIDF which may provide scale and improve cost of financing of the RIDF Ÿ Promote showcase pilot projects for financial assistance under RIDF Eligible Projects / Ÿ Portfolio quality and compliance with DfID eligibility requirements companies Ÿ First level o Ticket size to be decided to enable financing for medium size RE players o The minimum stand-alone credit rating of the project / Proposed bond issue to be credit enhanced should be at least ‘BB’ o The infrastructure project should have achieved COD / provisional COD o 85% of capacity under PPA requirements Ÿ Second Level: Due diligence – keeping in view the regulations and DfID/ intermediary rules. For instance, creditworthiness of sponsor; commercial review of EPC warranties and performance guarantees; credit profile of module provider, arrangement for sale of power etc.

Key design element & Term Ÿ Loan terms : Duration of loan to be in line with long term PPA duration and condition Ÿ Careful selection of projects based on the credit worthiness of offtaker Ÿ Share retention by sponsors of at least 49% for a minimum 2 years after taking loan facility Ÿ Limited exposure to one group company Reporting and Monitoring Ÿ Intermediary will be required to continuously monitor the performance of the project loans and submit quarterly reports to DfID or other related entities. Ÿ Portfolio quality and compliance with DfID eligibility requirements

Accelerated Deployment of Renewable Energy Sector 5.3.7 Implementation pathway

DfID and PTC India Financial Services Limited (PFS)60 , an Infrastructure-Non Banking Financial Corporation have signed a MoU for co-operation to work to design, develop and launch RIDF and promote and showcase pilot projects for ﬁnancial assistance under the RIDF The implementation pathway for the ﬁnancial instrument proposed has been detailed out below:

Sl. No. Implementation pathway

1 Identify the assistance which can be provided to scale RIDF e.g. Direct Investment, access to debt raising from international markets, including international guarantees

2 Understand costs and other considerations from MFI and understand various fund sourcing options for RIDF including various types of capital i.e. Tier-1 equity, Tier-2 capital and debt

3 Finalizing the legal structure of transactions subject to regulatory limits

4 Road shows and showcase to promote the product

5 Roll out with a pilot to showcase the product

60 PFS is engaged in the business of making investments in, and providing financing solutions to companies with projects in the power sector and related areas across the energy value chain with prime focus to provide financing to renewable power projects. PFS has sanctioned highest number of renewable power projects in last two financial years i.e. FY 2015-16 & FY 2016-17. A major part of PFS’ assistance has been towards renewable energy.

Accelerated Deployment of Renewable Energy Sector 6. Way forward – Larger intervention required 6. Way forward – Larger intervention required

In addition to ﬁnancial issues, stakeholders have highlighted other constraints that need to be addressed to build ﬁnancial momentum in the renewable energy sector. The interventions required are the following:

Ÿ Policy interventions are required to mobilize investment at the pace and scale necessary. The right policy settings and incentive structures adopted will enable RE investment to scale up to the needed levels in India. Some interventions highlighted by stakeholders include making revisions to credit rating standards to reﬂect the Indian context, revision of quality standards for modules to reﬂect Indian conditions, creating a long-term stable policy environment to allow and attract domestic institutional investors to invest in the RE sector, including on aspects such as open access provisions, exemptions provided to RE and must-run status.

Ÿ Commercial interventions to protect the sector against critical risks such as payment delays, non-honoring of PPAs and curtailment risk, which are having a significant impact on investors and likely to slow down the sector growth, are needed. The sector requires more sophisticated and standardized payment mechanisms and risk mitigation structures across states. Ÿ Capacity-building interventions are required to create tools and methodologies for long-term integrated power planning, which keeps in view a high RE scenario and prepares utilities and states for adverse impact. Ÿ Technical interventions, such as improving transmission infrastructure and development of the robust ancillary market, will be paramount to tap India's RE potential and integrate the power effectively. There is also need for a credible organization for independent testing of working of panels to improve the overall quality of projects. These challenges need to be addressed through separate but co-incidental efforts to maximize the benefits from efforts aimed at addressing financing bottlenecks. India is likely to be one of the largest renewables markets in the future, and there are enormous opportunities that can be tapped into. The country is also the crucible of frugal innovations. Financial innovation is a key driver to accelerated growth of renewables in India. An important part to enable financial innovation is the development and implementation of innovative financing mechanisms and instruments. The country can collaborate with counties with rich experience in green financing, in terms of implementing these innovations, which shall entail capacity building of key stakeholders (Commercial banks, regulators, credit agencies, etc.), driving pilots/ case studies and eventual implementation of these financial products.

Accelerated Deployment of Renewable Energy Sector Appendix 6.1 Other Financial Instruments 6.1.1 Renewable Energy Asset Platform 6.1.1.1 Background

Infrastructure Investment Trust (InvIT) is a fairly new concept in Indian ﬁnancial sector, and till date has been exercised by only two entities, IRB Infrastructure's IRB InvIT Fund in road sector and Sterlite Grid's - India Grid Trust in Power Transmission sector61 .

InvIT is a collective investment vehicle that enables developers of infrastructure assets/SPVs to monetize their assets by pooling multiple assets under a single entity (trust structure). InvITs are governed by SEBI (Infrastructure Investment Trusts) (Amendment) Regulations, 2016. InvITs enable sponsors to raise funds from public/ capital markets and help 1) Monetize equity investments in operational assets, 2) Take out existing lenders, and 3) Create headroom for investments in future assets. Apart from equity to developers, InvITs also enables raising of long-term debt through reﬁnancing, by tapping niche investors, viz. pension funds, insurance companies and sovereign wealth funds. Ÿ InvITs are positioned as high-dividend paying investments suitable for investors who are especially looking for long-term, stable cash ﬂows with moderate capital appreciation. Investors of InvITs can draw comfort from a favorable tax-regime designed around this instrument. Some of the key features of InvIT are: Ÿ Dividend income is tax exempt at the trust as well as unit holder level

Ÿ No capital gains are levied if units are held for over 3 years and sold through the exchange.

Ÿ Further, there is a pass-through structure of InvITs mandating distribution of a minimum 90% of net- distributable cash and nil dividend distribution tax62 .

Ÿ Thus, InvITs can potentially attract institutional investors such as insurance funds and pension funds, and other large investors looking at more or less stable stream of returns from cash ﬂow yielding infrastructure assets.

61 These issues were oversubscribed by 1.35 (Sterlite) and 8.57 (IRB) times and saw participation of foreign institutional investors such as Deutsche Global Infrastructure Fund, Future Fund Board of Guardians managed by Rreef America LLC, Driehaus Emerging Markets Small Cap Growth Fund and Jupiter South Asia Investment Co. Ltd. 62 Long term capital gains (LTCG), where units held for over 36 months, would be tax exempt for both resident and non-resident unit holder (foreign investor). Interest income shall be taxable in the hands of unit holders and would attract withholding tax @ 5%/ 10% for non-resident and resident unit holders respectively. In case of non-resident unit holders, beneﬁcial tax regime under a Double Taxation Avoidance Agreement (‘DTAA’) entered into between India and the country in which the offshore Investor is resident, if any, shall be available.

Accelerated Deployment of Renewable Energy Sector While larger developers with diversiﬁed portfolio could potentially launch such InvITs on their own, smaller developers may not have the desired scale to set up an InvIT for accessing capital markets. Such smaller developers typically face constraints in seeking monetization or fresh capital raise for new projects. In such a scenario, it can be examined whether an independent InvIT, could be established and could potentially act as a platform for monetization of investments in projects for smaller developers. With the aim to have sector speciﬁc monetization structures, Renewable Energy Asset Platform (“REAP”) is suggested. 6.1.1.2 Instrument description and USP

In the suggested model, REAP shall be ﬂoated by a third party acting as a Sponsor – which could be an MFI and/ or its associates instead of a developer. The REAP will act as a platform for small to medium developers to monetize their assets. The transaction will occur at two levels,

- First, wherein RE developer (s)will transfer its asset(s) to the sponsor of REAP and partly or fully monetize its equity investment, this transaction shall be either of cash transactions or share transfer, depending upon the InvIT regulations allow. - second, the REAP will issue fresh units (to the investors) against the asset(s).

This structure will allow multiple small developers to monetize their assets which otherwise may not be feasible.

However, it may be noted that the suggested structure is not covered as per the existing regulatory framework and will require changes in the same. 6.1.1.3 Business case for the instrument

As per the stakeholders consultations carried out by KPMG, there is likely to be a gap of 50-70 GW between the RE target of 175 GW by FY2022 and the current capacity addition plan of key entities in the RE sector. This gap can be ﬁlled by a more broad based growth which may see greater participation from smaller RE players. One of the enablers for such broad based growth shall be mechanisms for monetization of existing investments (equity) in their projects and ability to seek public capital for new projects.

RE InvIT will also be available to large developers. Several such assets have been in the market seeking monetization avenues or fresh capital. 6.1.1.4 Current InvIT Structure

Ÿ Sponsor: Company or LLP or body corporate which sets up the InvIT. Such entity is required to have net worth of not less than 100 crores, and net tangible assets of value INR 100 crores or more. The sponsor should also have minimum ﬁve year of track record in development of infrastructure assets. Sponsor lock-in for 15% of the shareholding for 3 years from the date of issue Ÿ Trustee: A person who holds the InvITs’ assets in trust for the beneﬁt of the Investors (unit holders). Ÿ Investment Manager: Shall make the investment decision including any further investments. Ÿ Project Manager: Shall take care of operations and management of InvITs assets. Ÿ Investors: NBFCs, Commercial banks, MFIs, Foreign portfolio investors

Accelerated Deployment of Renewable Energy Sector Figure 39 InVITs Structure

§ Sponsor sets-up a trust and appoints an independent trustee § InvITs structure Trust to be registered as InvIT with SEBI Aggregate consolidated § Sponsor – Not more than 3 borrowings and deferred § Sponsor/ Investor Lock in period – 3 years from the date of listing payments capped at 49% of § At-least 25% of total outstanding units of InvIT to be value of assets offered to public 90% of net Ownership of distributable cash Units Manages the Trust and ﬂow acts on behalf of the Makes investment decisions with Unit Holders respect to underlying assets/projects Trustee Investment InvIT Manager Appointment Appointment Responsible for execution of projects/ meeting project Direct Appointment ownership milestones (for PPP) >=50% Project SPV* 90% of net Manager Infrastructure distributable cash ﬂow assets held by Infrastructure assets *Multi layer SPV structure proposed InvIT held by SPV#

Ÿ Cap on leverage to be less than 49% of the net asset value 6.1.1.5 Proposed structure and its beneﬁts

The proposed structure of REAP is shown below. It needs to be examined whether,

1) REAP shall be permitted, and what changes will be required in the regulations

2) MFIs or overseas funds could act as a sponsor for a RE InvIT.

3) How legal and taxation structures work around the transaction

This will be examined through discussions with merchant bankers and close consultation with SEBI.

Accelerated Deployment of Renewable Energy Sector Figure 40 Renewable Energy Asset Platform (REAP)

§ REAP sponsored by MFI and its associate instead of RE developers § RE InviT will be a platform for RE developers with REAP Investors medium to smaller scale of operations 90% of net § MFI and its associate being the sponsors will increase distributable invertor conﬁdence Ownership of Units cash ﬂow Manages the Trust and acts on Makes investment decisions with respect to behalf of the Unit Holders underlying assets/projects Investment Trustee InvIT Manager Appointment Appointment

Responsible for execution of projects/ meeting Direct ownership Appointment project milestones (for PPP)

>=50% SPV 90% of net distributable cash Project Manager Infrastructure assets ﬂow held by InvIT Infrastructure assets held by SPV

Since, third party InvITs are not allowed in the existing regulations (no speciﬁc disallowance but the various stipulations limit such structure), it will require various approvals and changes in regulatory structures, in close consultation with SEBI. Some of the regulatory issues are depicted the Table below:

Table 20 Regulatory Issues

Sl. No. Key issues Description

1 Sponsor should have minimum Limited operational experience of developers, since experience of 5 years RE sector has started to take pace 2-3 years back, only few players will have scale and required experience to set InvITs. 2 Sponsor deﬁnition As per guidelines, ”sponsor” means any company or LLP or body corporate which sets up the InvIT and is designated as such at the time of application made to the Board and in case of PPP projects, shall mean the infrastructure developer or a special purpose vehicle holding concession agreement. The regulations are not clear whether FI can be sponsors

3 Tax treatment Tax treatment of transfer of assets from developers to REAP

Accelerated Deployment of Renewable Energy Sector 6.1.1.6 Proposed structure and its beneﬁts

The structure is presently not explored and the support from MFIs can elicit favourable responses from the regulatory agencies. To that extent, MFIs can play a key role in enabling the structure itself.

MFI acting as a sponsor (or backing a sponsor (s)) can be critical in driving investors' conﬁdence and participation in such issues. Also, relatively long term investment horizon of MFIs may also drive attractive valuations for developers and investors alike. 6.1.1.7 Proposed structure and its beneﬁts

The implementation pathway will be crucial from the point creating a legal structure for involvement of REAP to ﬂoat a InvITs. Hence, detailed stakeholder discussions and addressing regulatory barriers will be crucial.

The implementation pathway will be detailed once the stakeholder consultations are done for the ﬁnancial instrument proposed. However, a broad plan as DFID moves towards implementation phase is as follows:

Sl. No. Implementation pathway

1 Stakeholder consultations for the instruments (merchant bankers, MFIs, developers, overseas investors, regulators and legal institutions)

2 Suggest structures for involvement of MFI in the RE InVITs. Understand tax and other considerations.

3 Development of a pipeline of developers interested in the product

4 Framework to select the intermediaries such as merchant bankers, credit rating agency, underwriters, etc 5 Finalization of the instrument structure in discussion with MFI and merchant bankers

6 Roll out

6.1.2 REAT Fund of Funds 6.1.2.1 Background

Currently, India does not have any large renewable (RE) and associated technology63 focused funds (equity or debt). Majority of the funds are focussed at larger infrastructure sector64 or are focused for larger regions than speciﬁc country65 . Hence RE projects have to compete with other infra sub-sectors and other countries. These funds are important from perspective of bringing in focused investors looking to expand their portfolio in RE

63 Associate technologies such as Storage, EV etc. 64 Funds such as IDFC’s India Infrastructure Fund (IIF); ADB’s and JICA’s – Leading Asia’s Private Sector Infrastructure Fund (LEAP), Government of India’s National Infrastructure Investment Fund 65 Renewable Energy Asia Fund I & II (REAF) funded by Global Energy Eciency and Renewable Energy Fund

Accelerated Deployment of Renewable Energy Sector sector. However, with varying risk appetite and corresponding return expectation, such funds may not be able to make available capital to the RE sector at optimal cost.

On the other hand, Government of India (GoI) has recently proposed to set up a “Clean Energy Equity Fund” (CEEF) with initial pool of up to USD 2 bn. The initial pool will be shared between state run companies such as NTPC66 , IREDA67 , REC68 and GoI promoted National Investment and Infrastructure Fund (NIIF)69 . However, given the scale of investments planned in the renewables sector in India, multiple such funds are needed.

Accordingly, a fund of funds (FOF) with mandate to invest in PE funds focused on RE and associate technologies or partner with RE funds on deal by deal basis is suggested. This may be able to attract relevant group of investors ensuring the alignment of return expectations and investment proﬁle. The cost of capital of these funds can be further reduced with support from MFIs/ IFIs70 .

These sector speciﬁc fund of funds are fairly common in Europe and are funded through pool of funds from varied investor’s e.g. budgetary funds, Development banks and Private Investors.

One such fund – Global Energy Eciency and Renewable Energy Fund (GEEREF) has an India focused solar asset vehicle (Euro 12 Mn) – Solar Arise71 also. 6.1.2.2 Instrument Description and USP

“RE & Associated Technology” (REAT) fund of funds in India can be set up under SEBI’s (Alternative Investment Funds) regulations 2012, similar to NIIF (Category II AIF) which can raise debt to invest equity in other funds and NBFCs.

REAT fund of funds can be created with pooling in various investor with different risk proﬁles and looking for expanding portfolio in RE and associated technologies. The class A & B with equity and mezzanine risk can be injected through anchor partners such as development/ multilateral banks, class C & D with junior and quasi- senior loan risk by public or private impact investors. The fund then can issue notes/bonds to create leverage and invest in other equity funds to further increase the leverage and impact.

The presence of MFIs/ IFIs (“MFI”) as the anchor sponsors could help in lowering the cost and returns requirement making it cost optimal for RE sector.

66 NTPC Limited is India’s largest energy conglomerate with the total installed capacity of 51,410 MW (including JVs) with 20 coal based, 7 gas based stations, 1 Hydro based station and 1 Wind based station. The company targets non-fossil fuel based generation capacity to reach nearly 30% of its portfolio by 2032. 67 Indian Renewable Energy Development Agency Limited (IREDA) is a Public Limited Government Company established as a Non-Banking Financial Institution in 1987 engaged in promoting, developing and extending financial assistance for setting up projects relating to new and renewable sources of energy and energy eciency/conservation 68 Rural Electrification Corporation Limited (REC) is a Non-Banking Financial Company with 'Infrastructure Finance Company' status. Its main objective is to finance and promote power sector projects in India. 69 Government of India’s Infrastructure focused fund which is set under AIF regulations as a trust 70 Multilateral Financing Institutions/ International Financing Institutions 71 GEEREF is an innovative Fund-of-Funds, investing in specialist renewable energy and energy eciency private equity funds developing small and medium-sized projects in emerging markets. By the end of 2013, GEEREF had signed commitments to 6 funds across Africa, Asia, Latin America and the Caribbean.

Accelerated Deployment of Renewable Energy Sector 6.1.2.3 Business case for the instrument

The two important sector aspect “REAT Fund of Funds” will focus on are:

- Broad based growth – To meet RE targets and INDC commitments, new and medium players will be required to ﬁll the capacity addition gaps. However, currently equity investments is skewed toward established players, and enabling broad based growth would require focus ﬁnancing vehicles. - Growth in associated technology - RE capacity addition can take a leap jump if associated technologies such as storage can achieve scale and eciency. Hence, development of associated technologies would be crucial for sustainable growth of renewable energy. The fund can focus on early stage investments in these technologies which otherwise be dicult due to relatively high risks. 6.1.2.4 Structure of REAT Fund of Funds

Akin to NIIF and several sector speciﬁc fund in Europe, the REAT fund of funds will have following entities, Ÿ Anchor Partners: The fund would be sponsored by MFIs as anchor partners and taking the equity risk in the fund. Ÿ Class B Investors: These investors will subscribe to mezzanine risk in the fund. These investors would be public and/ or private investors Ÿ Class C & D Investors: These investors will subscribe to junior loan in the fund and would be patient investors such as Institutional investors.

A fund structure is presented below:

Accelerated Deployment of Renewable Energy Sector Figure 41 REAT Fund of Funds

Market Borrowings

Raise Debt Sponsors/Equity Anchors Partners Sponsors/Equity Class A Class B Class Class B Investors Equity Mezzanine C&D Multilateral, Bilateral Risk Risk Junior Loan Class C&D Investors REAT Funds of Funds

Equity Investments

Equity Investments Equity Investments Equity Investments

Poor States RE Storage Projects/RE funds Funds Funds

REAT Fund of Funds by investing in other funds would enable more leverage and diversiﬁcation in project will further reduce the associated risk. 6.1.2.5 Prior Examples

GEEREF is an innovative Fund-of-Funds, investing in specialist renewable energy and energy eciency private equity funds developing small and medium-sized projects in emerging markets. By the end of 2013, GEEREF had signed commitments to 6 funds across Africa, Asia, Latin America and the Caribbean. Some of these funds are, European Fund for South East Europe (EFSE) – focussed primarily at micro ﬁnance, Green for Growth – primarily renewable energy, European Energy Eciency Fund (EEEF) – energy eciency investments, Marguerite – equity investments in large infrastructure projects. These funds have enabled pipeline of projects in multiple sectors. 6.1.2.6 Value addition from MFI/ IFI

MFIs with signiﬁcant experience of such funds are best placed to conceptualize and market these to private sector investors in the developing countries. Fund of Funds will also enable greater leverage and impact for the investments made by MFIs.

Accelerated Deployment of Renewable Energy Sector 6.1.2.7 Implementation Pathway

The implementation pathway will be detailed once the stakeholder consultation are done for the ﬁnancial instrument proposed. However, a broad plan as DFID moves towards implementation phase is as follows:

Sl. No. Implementation pathway

1 Stakeholder consultations for the instruments (merchant bankers, MFIs, developers, overseas investors)

2 Understand costs and other considerations from MFI and co-opting opportunities

3 Framework to select the other investors

4 Creating pipeline of investors

5 Roll out

6.1.3 Hybrid Investment Model 6.1.3.1 Background

India’s ability to meet its renewable energy target (175 GW by FY 2022) and INDC commitments72 will depend on the State’s ability to harness their renewable energy (RE) potential and meet existing targets. Most of the states are in initial phase of RE implementation, as only few states have achieved 50% of their RE targets e.g. Karnataka (KR), Tamil Nadu (TN) and Rajasthan (RJ). Going forward performance of these states will be crucial since these states are already facing concerns such as transmission constraints, back down of RE generation and issues of grid integrations.

On the other hand, states such as UP73 and Bihar74 have had challenges to build pipeline of RE projects. The reasons being poor ﬁnancial health of utility and lower investor conﬁdence in the states.

Thus, in long term, states to meet their RE targets will be driven by their capability to reduce the associated risks such grid integration, utility ﬁnances, curtailment and counterparty75 etc. to enable investor conﬁdence.

Furthermore, these states will have to be supported with reforms in the overall power sector including comprehensive and detailed capacity planning for seamless integration of large RE capacities into the state grid, improving state utility ﬁnances though better implementation of UDAY76 , etc. MFIs/ IFIs77 (“MFI”), with their technical expertise and ﬁnancial strength, are well placed to support and handhold States in implementing such reforms and overall capacity building.

72 40% share of non-fossil fuel sources in India’s overall power generation capacity by 2030 73 RE target Realization of 8% as on March 2016 74 RE target realization of ~0% as on march 2016 75 Delay in payment and not necessarily non-payment 76 Central Government scheme to improve state distribution utilities ﬁnancial health 77 Multilateral Financial Institutions / International Financial Institutions

Accelerated Deployment of Renewable Energy Sector The figure below lays down the broad framework which MFIs can potentially follow to adopt states for RE development. An important part of financial innovation is to develop such frameworks which could lead to better risk management and thereby improving investors’ confidence.

Figure 42 Framework for RE deployment in States

Creating new RE pipeline in state Ÿ Better policies for creating RE capacity and absorption of RE Ÿ Project Structuring to enable investment e.g. REWA Creating like solar park, commercial arrangements etc. RE Ÿ Enabling investors conﬁdence by addressing key risks Pipeline and issues like Dispatchability, Assets quality, Off taker Risk

Enabling Financing support Ÿ Capital ﬂow in states for RE development e.g. Solar Parks, Solar Roof-top and Themes off grid for RE Ÿ Improving Discoms development Technical assistance and ﬁnancing, UDAY Capacity Building for RE Enabling implementation assistance Enabling integration RE Financing Ÿ Grid Integration Integration Ÿ Cycling of coal plants Ÿ Adopting Storage technologies Ÿ Capacity building of Distribution Utilities

An instance of such broader involvement of MFIs in Indian RE sector was witnessed in the case of REWA solar park. In Rewa, project structuring led to better risk management78 and thereby debottlenecking the investments. This kind of MFI involvement can be aligned to Leg 1 of the framework i.e. “Creating RE pipeline” (see ﬁgure above)

Thus, similar interventions are particularly relevant with respect to RE projects in the poor states79 in India, as they had challenges to increase their RE uptake. MFIs can potentially play a role in enabling RE projects in such states at competitive tariffs, which otherwise may not be feasible due to lower investor conﬁdence in the states. The suggested structure is aimed at reducing the risk for developers by involvement of MFI is “Hybrid Investment Model80 ”. 6.1.3.2 Instrument Description and USP

The suggested “Hybrid Investment Model” is variation of the model adopted in REWA solar park. In addition to risks mitigation measures in Rewa. The structure proposes MFI investments in solar park infrastructure e.g.

78 Deemed generation status to mitigate curtailment risk and three tier payment mechanism to mitigate delays in payment 79 In terms of per capita income 80 Similar in line with Hybrid Annuity Model in road projects

Accelerated Deployment of Renewable Energy Sector Transmission evacuation etc. MFI may charge infrastructure charges in (INR/kWh) over the period of 10-15 years, rather than upfront cost, and in turn will reduce the cost of developers and project returns. With MFI investing and enabling developing park infrastructure will increase private investments in the poor states. MFI will also be the transactional advisor for the project. 6.1.3.3 Business case for the instrument

RE capacity growth in some of the poor states has been lagging behind the potential/ target, possibly constrained by factors such as investors’ low conﬁdence in the discom ﬁnances, high risk perception and poor infrastructure development.

RE scenario in bottom ﬁve states (in terms of per capita income, excluding NE states)81 - States in increasing order of per-capita income

Table 21 State Wise RE Realization and Targets

RE potential, RE target, RE installed capacity Target States 82 83 84 in GW in GW as on FY2016, in GW realization Bihar 13 3 <0.05 ~0%

Uttar Pradesh 28 14 1.1 8%

Jharkhand 19 2 <0.05 1%

Madhya Pradesh 67 12 3.0 25%

Odisha 28 2 0.1 5%

Total 155 33 4.2 13%

Source: MNRE, KPMG Analysis

These ﬁve states account for roughly one ﬁfth of the RE target for India. Thus creating pipeline of projects in these states is crucial for India to meet its 175 GW target. 6.1.3.4 Proposed structure

The project structure will include,

Ÿ Capital investment by MFI for developing supporting infrastructure, Ÿ Enabling payment security mechanisms; and Ÿ Frameworks of deemed generation and guaranteed minimum offtake

81 Source: http://pib.nic.in/newsite/PrintRelease.aspx?relid=123563 82 Including wind potential of 103 GW (and not ~300 GW at 100m mast height) 83 As on March 2016 84 Bio-mass and Small Hydro capacity as on December 2015

Accelerated Deployment of Renewable Energy Sector Figure 43 Hybrid Investment Model

State A Solar Park Ltd. MFI/IFI

Develop Solar park Solar Park Assets Procurer Infrastructure

INR/kWh infra charges over 15 years

IPP 1

MFI/IFI to be Bidders to be based on transaction advisor reverse actions

6.1.3.5 Prior examples

Ÿ In road sector in India, banks were reluctant to fund private sector due to relatively poor performance of projects awarded on Viability Gap Funding (VGF) model. The key concern was trac risk which led to revenue risks; and ﬁnancial distress due to aggressive bidding. Hybrid Annuity Model (HAM) in the road sector, where NHAI took share in the capital cost of the road assets, helped stressed private players due to reduced capital requirement. Trac risk was also mitigated due to agreed annuity.

Ÿ In renewables sector in India, the project structure in REWA enabled reduction in the risk for the developers including,

– Offtake Risk: Guaranteed Energy Offtake by procurer; in case of shortfall, developers to be compensated for the shortfall – Curtailment Risk: Non/ Partial availability of Transmission system and backing down from RLDC will be considered as deemed generation

– Payment Risk: State Government payment guarantee if procurer does not pay in time It is estimated that the risk reduction led to lowering of tariffs by ~35-40 paise per unit. 6.1.3.6 Value addition from MFI

MFI adopting states to provide technical and ﬁnancial assistance for holistic deployment of RE will send strong signals to the investors. Addressing risks and challenges to increase RE uptake will enable capital ﬂow in the states.

Accelerated Deployment of Renewable Energy Sector “Hybrid Investment Model” is one of the potential way for MFI to support RE development and create project pipelines in states which otherwise had challenges. 6.1.3.7 Implementation Pathway

The implementation pathway will be detailed once the stakeholder consultation are done for the ﬁnancial instrument. However, a broad plan as DFID moves towards implementation phase is as follows:

Sl. No. Implementation pathway

1 Ÿ Stakeholder consultations for the instruments (merchant bankers, MFIs, developers, overseas investors) Ÿ Evaluating co-opting opportunities with other MFIs

2 Suggest structures and Understand costs and other considerations from MFI

3 Framework to select the stakeholders and States where such structures can be implemented

4 Development of a pipeline of developers interested in the product

5 Roll out

100

Accelerated Deployment of Renewable Energy Sector List of abbreviations

AIF Alternate Investment Funds ALM Asset Liability Mismatch Bn. Billion CAGR Compounded Annual Growth Rate CapEx Capital Expenditure CEA Central Electricity Authority CERC Central Electricity Regulatory Commission Crs. Crores CUF Capacity Utilization Factor DEWA Dubai Electricity and Water Authority Discom Distribution Company ECB External Commercial Borrowings EPC Engineering Procurement Construction EXIM Export Import FDI Foreign Direct Investment FY Financial Year GDP Gross Domestic Product GoI Government of India GTD Generation Transmission Distribution GW Giga Watt IDFC Infrastructure Development Finance Company IFC International Finance Corporation IIFCL Indian Infrastructure Financing Corporation Limited Infra. Infrastructure InvITs Infrastructure Investment Trusts IoL Interest on Loan IPO Initial Public Offering IREDA Indian Renewable Energy Development Agency Limited IDF Infrastructure Debt Fund List of abbreviations

IFI International Financing Institution IWC Interest on Working Capital KW Kilo Watt kWh Kilo watt Hour (Unit) LLP Limited Liability Partnership M&A Mergers and Acquisitions MCLR Marginal Cost of Lending Rate Mn. Million MU Million Units NBFCs Non-Banking Financial Company NPA Non-Performing Assets NTPC Nation Thermal Power Corporation Limited O&M Operation and Maintenance PE Private Equity PFS PTC India Financial Services Limited PIK Payable in Kind PPA Power Purchase Agreement PV Photo Voltaic RBI Reserve Bank of India RE Renewable Energy REC Rural Electriﬁcation Corporation Limited REITs Real Estate investment Trust RoE Return on Equity RPO Renewable Purchase Obligation SEBI Securities and Exchange Board of India SECI Solar Energy Corporation of India Limited SHP Small Hydro Power SPV Special Purpose Vehicle VGF Viability Gap Funding

Contact Details Nishant Bhardwaj Energy Adviser Department for International Development Email: enquiry@dﬁd.gov.uk

Anish De Programme Director Power Sector Reform Programme Email: [email protected]