RE Finance Report

Partnership to Advance Clean Energy - Deployment (PACE - D) Technical Assistance Program Financing Renewable Energy in India: A review of current status and recommendations for innovative mechanisms

October 2013 This report is made possible by the support of the American People through the United States Agency for International Development (USAID). The contents of this report are the sole responsibility of Nexant, Inc. and do not necessarily reflect the views of USAID or the United States Government. This report was prepared under Contract Number AID-386-C-12-00001. INDIA

Partnership to Advance Clean Energy - Deployment (PACE - D) Technical Assistance Program Financing Renewable Energy in India: A review of current status and recommendations for innovative mechanisms

Executive Summary...... 1

1. Potential for RE in India ...... 5

1.1 Current Scenario ...... 5 1.2 RE Potential ...... 5 1.3 Drivers of RE...... 7

2. Policy Support for RE in India ...... 9 2.1 Tax Incentives ...... 10 2.2 Feed-in Tariffs ...... 12 2.3. Renewable Energy Purchase Obligations ...... 13 2.4 Renewable Energy Certificates (RECs)...... 14 2.5 Subsidies...... 15 2.6 Generation Based Incentives ...... 18 2.7 Including Off-grid RE Projects in Priority Sector Lending...... 18

3. Business Models for RE Projects In India...... 19 3.1 Grid Connected RE ...... 19 3.2 Rural Electrification Projects ...... 23 3.3 Commercial and Industrial Off-grid RE Projects...... 23

4. Commercial Financing Instruments for RE in India ...... 25 4.1 Debt Instruments...... 25 4.2 Equity Finance ...... 34 4.3 Mezzanine Finance ...... 36 4.4 Partial Risk Guarantee Facilities...... 37 4.5 Rural Off-grid Financing ...... 40

5. Barriers to RE Finance in India ...... 43 5.1 Policy Level Barriers...... 43 5.2 Market Based Barriers ...... 46 Table of Contents

Executive Summary...... 1

1. Potential for RE in India ...... 5

1.1 Current Scenario ...... 5 1.2 RE Potential ...... 5 1.3 Drivers of RE...... 7

3. Business Models for RE Projects In India...... 19 3.1 Grid Connected RE ...... 19 3.2 Rural Electrification Projects ...... 23 3.3 Commercial and Industrial Off-grid RE Projects...... 23

5. Barriers to RE Finance in India ...... 43 5.1 Policy Level Barriers...... 43 5.2 Market Based Barriers ...... 46 5.3 Barriers to Rural Off-grid Projects ...... 47 List of Tables 5.4 Barriers to Commercial Off-grid Projects ...... 49

5.5 Gaps and Needs in RE Financing...... 49 Table 1: Business Models for Grid-Connected RE Projects ...... 21

6. Suggestions for Innovative Financing Mechanisms for Table 2: Prominent FIs Providing Rupee Term Loans to RE Projects...... 26 RE in India...... 53 Table 3: Mutual Benefits of Lease Financing to FI and Project Developer ...... 33 6.1 Fiscal Mechanisms ...... 54 6.2 Policy Mechanisms ...... 59 Table 4: Characteristics of Infrastructure Debt Funds in India...... 61 6.3 Financing Mechanisms ...... 60

Acronyms ...... 73

References...... 77

Annex A: Summary of Solar Reverse Bidding Programs...... 79

Annex B: Capital Subsidy for Grid Connected Biomass Power Projects and Bagasse Cogeneration Projects ...... 80

Annex C: Capital Subsidy for Grid Connected Gasifier Projects...... 81

Annex D: Capital Subsidy for Biomass Gasifier for Industrial Use ...... 82

Annex E: Capital Subsidy for Grid Connected Biogas Projects ...... 83

Annex F: Capital Subsidy for Off-Grid Watermills and Micro Hydro Projects ...... 84

Annex G: Capital Subsidy for Off-Grid Solar PV Applications ...... 84

Annex H: Renewable Purchase Obligation Targets...... 85

Annex I: Examples of Investments in Grid Connected RE Projects Using Commercial Instruments ...... 88

Annex J: Funding for Husk Power Systems ...... 91

Annex K: Tax Efficient Structures...... 92

Annex L: Companies Adopting Singapore Trust Route...... 94

Annex M: Examples of Green Bond Issuances...... 95 5.3 Barriers to Rural Off-grid Projects ...... 47 List of Tables 5.4 Barriers to Commercial Off-grid Projects ...... 49

5.5 Gaps and Needs in RE Financing...... 49 Table 1: Business Models for Grid-Connected RE Projects ...... 21

Acronyms ...... 73

References...... 77

Annex A: Summary of Solar Reverse Bidding Programs...... 79

Annex B: Capital Subsidy for Grid Connected Biomass Power Projects and Bagasse Cogeneration Projects ...... 80

Annex C: Capital Subsidy for Grid Connected Gasifier Projects...... 81

Annex D: Capital Subsidy for Biomass Gasifier for Industrial Use ...... 82

Annex E: Capital Subsidy for Grid Connected Biogas Projects ...... 83

Annex F: Capital Subsidy for Off-Grid Watermills and Micro Hydro Projects ...... 84

Annex G: Capital Subsidy for Off-Grid Solar PV Applications ...... 84

Annex H: Renewable Purchase Obligation Targets...... 85

Annex I: Examples of Investments in Grid Connected RE Projects Using Commercial Instruments ...... 88

Annex J: Funding for Husk Power Systems ...... 91

Annex K: Tax Efficient Structures...... 92

Annex L: Companies Adopting Singapore Trust Route...... 94

Annex M: Examples of Green Bond Issuances...... 95 List of Figures Acknowledgements

Figure 1: Potential vs. Installed Capacity of RE in India...... 6 This report was prepared by a team of consultants including Nexant, Inc., Emergent Ventures India (EVI), and SRC Global Inc. Figure 2: Structure of Lease Financing in India ...... 33 (SRC), under the Partnership to Advance Clean Energy - Figure 3: Structure of Partial Risk Guarantee Facilities...... 38 Deployment (PACE - D) Technical Assistance Program, which is funded by the United States Agency for International Figure 4: Suggested Financial Mechanisms...... 51 Development (USAID). The principal authors of this report were Aseem Varma and Ranjit Chandra of EVI, and Dilip R. Limaye of Figure 5: Typical Structure of a Business Trust...... 55 SRC. Technical input and comments were provided by Aloke Figure 6: Climate Themed Bonds ...... 63 Barnwal and Vinod K. Kala of EVI. The report was prepared under the direction of Sanjay Dube, Nexant's Chief of Party, along with Figure 7: Structure of IDF-NBFC...... 67 a Nexant team comprising Ronnie Khanna, Kavita Kaur, Peter du Figure 8: Structure of IDF-MF...... 68 Pont, Jem Porcaro and Aalok Awalikar. The report was edited by Nidhi Jamwal. Figure 9: Insurable Risks for RE Projects ...... 71 The PACE-D Technical Assistance Program would like to express its sincere appreciation and gratitude to the numerous experts in India who were interviewed by the program and who provided useful information on their experience and insights on renewable energy financing in India. Additionally, we would like to thank members of the Advisory Team for Renewable Energy Finance, who provided valuable input during the design of the report, and suggestions to guide the research.

We would like to thank Alok Srivastava, Joint Secretary, Ministry of New and Renewable Energy and his team for their valuable inputs.

Finally, we would like to thank Monali Zeya Hazra, Anurag Mishra, Apurva Chaturvedi, and S. Padmanaban of USAID/India, who provided extensive input throughout the report preparation period. Their thoughtful feedback helped shape the report and focus it on the design of innovative financing mechanisms that could be useful in the Indian context. List of Figures Acknowledgements

We would like to thank Alok Srivastava, Joint Secretary, Ministry of New and Renewable Energy and his team for their valuable inputs.

India's renewable energy (RE) potential is estimated to be more than 3,000 GW based on existing identified resources. While RE sources have been harnessed for electricity generation in India for the last three decades, only 29.8 GW – which is less than one percent of the total potential has been tapped so far.

Over the past 10-15 years, both the central and the state governments have developed favorable policy frameworks to facilitate development of RE projects in the country. These include mechanisms such as feed-in tariffs (FiTs), capital subsidies, and tax benefits. These mechanisms have been successful in attracting significant investments and adding RE capacity. New policy instruments such as generation based incentives (GBIs), Renewable Purchase Obligations (RPOs), RE certificates (RECs) and open access (wheeling and banking) have provided further stimulus to the sector in the last few years. This has led to an annual growth rate of over 19 percent in RE capacity over the last five years (2007-2012).

The Government of India (GOI) views RE as critical to the country's sustainable growth. RE is also a key resource for the nation's energy security1 and energy access2. The GOI has set a target for 15 percent of power consumption to be generated from RE sources by 2022, up from the current share of five percent. To meet this target, the 12th Five-Year Plan of the Planning Commission includes an ambitious target to add 30 GW of RE between 2012 and 2017.3 In monetary terms, this means an additional capital requirement of INR 2.13 trillion (USD 34 billion)4, calculated based on the prevailing market costs. In addition to this, United Nations' Sustainable Energy for All Initiative estimates that India shall need an investment of USD five to seven billion annually till 2030 for facilitating energy access. Hence, finance will play a key role in the development of India's RE sector.

In the area of off-grid energy, financing of RE projects is currently driven more by “impact investors” than “financial investors”. There are also several risks associated with off-grid projects, such as unpredictable power consumption patterns; low creditworthiness of off-takers; and a lack of scalable business models. Most off-grid RE projects are small in size and fail to attract the attention of financial institutions (FIs). These barriers are exacerbated by the presence of policy and regulatory hurdles, which need to be addressed. In short, there is a need for policy and regulatory reforms, as well as new financing approaches, in order to ramp-up off-grid RE investments in India.

1 India energy imports are projected to be 53 percent of energy consumption by 2030. 2 Over 43 percent rural population and 7 percent of urban population does not have access to electricity as per Census of India, 2011. 3 Over and above the cumulative capacity of 29.8 GW so far. 4 Exchange rate, as on September 29, 2013, INR 62.58/ USD is considered Financing Renewable Energy in India 1 In the area of grid-connected energy, private financing instruments, such as debt, equity, mezzanine, sponsors, banks, investors, and state and national energy officials), the report presents and partial risk guarantees are being used in India. Despite the need to scale up, several gaps are recommendations on seven innovative financing mechanisms that can help India meet its future RE emerging. For example, a number of large financing sources are not participating in RE Investments financing needs. The mechanisms fall into three general categories of instruments: fiscal, policy, and yet; tax benefits are not uniformly accessible; capital market access has been limited; and private financial, as shown in the following figure. equity is tapering off as there are limited exit opportunities. Banks are facing an asset liability Seven Innovative Financing Mechanisms Recommended in this Report mismatch5, because long tenure debt is required for lending to RE projects. Banks are also reaching their lending limits6 for RE, which is considered a part of the power sector. • Tax efficient trusts (e.g. MLPs, REITs, Business Trusts) Based on research and inputs from stakeholders, the key needs identified to help scale up RE • Tradable AD Tax Credits financing in India are as follows:

• New financial approaches that can help independent power producers (IPPs) scale up Fiscal development of RE projects, including some of the following: o New sources of funds, for example: , Large investors such as pension funds, insurance companies, sovereign wealth funds, family funds, and sources of Islamic finance; , Access to capital markets; New financing , Participation by individual investors; instruments o Participation by international investors to meet the large investment needs of the future; o Mainstream debt financing options that allow longer-term, low-cost debt to be available Policy Financial at higher leverage ratios. • Increased availability of financial products suitable to each stage of a project's development • Green Bonds • REC Market Maker (e.g. pre-construction, construction, post commissioning, etc.). This eases migration from • Infrastructure Debt Funds one type of financing to the next as risks are reduced. • Off-Grid Fund • Appropriate policies, so that all classes of investors can benefit from incentives such as • Risk Insurance accelerated depreciation, tax holidays, RECs, and subsidies. Fiscal Instruments • Institutional arrangements and policies to help RE services companies (RESCOs) access • Tax Efficient Trusts: Tax efficient trusts provide pass-through tax benefits for investors in RE capital from new sources and scale up operations. projects, and can be traded publicly. They enhance capital market liquidity and provide • Mechanisms and products to reduce risks of RE investments. access to individual, retail and institutional investors. Such trusts have been used very successfully in the U.S., Singapore and other developed financial markets to access capital This report reviews recent experience with RE financing in India. Based on this research, as well as for sectors such as oil and gas and real estate; and are now proposed for RE. interviews with a range of practitioners involved in the sector (including project developers, project • Tradable Tax Credits: These are tradable tax-saving certificates that can be used by RE 5 An asset-liability mismatch occurs in a situation where the bank has substantial long-term assets (such term projects. For example they can be used by IPPs to avail the benefit of accelerated loans) but short-term liabilities, such as deposits depreciation. Such credits can help raise additional project finance and can reduce the 6 In order to diversify their risk across sectors, banks internally set lending limits for each sector

2 PACE-D Technical Assistance Program Financing Renewable Energy in India 3 In the area of grid-connected energy, private financing instruments, such as debt, equity, mezzanine, sponsors, banks, investors, and state and national energy officials), the report presents and partial risk guarantees are being used in India. Despite the need to scale up, several gaps are recommendations on seven innovative financing mechanisms that can help India meet its future RE emerging. For example, a number of large financing sources are not participating in RE Investments financing needs. The mechanisms fall into three general categories of instruments: fiscal, policy, and yet; tax benefits are not uniformly accessible; capital market access has been limited; and private financial, as shown in the following figure. equity is tapering off as there are limited exit opportunities. Banks are facing an asset liability Seven Innovative Financing Mechanisms Recommended in this Report mismatch5, because long tenure debt is required for lending to RE projects. Banks are also reaching their lending limits6 for RE, which is considered a part of the power sector. • Tax efficient trusts (e.g. MLPs, REITs, Business Trusts) Based on research and inputs from stakeholders, the key needs identified to help scale up RE • Tradable AD Tax Credits financing in India are as follows:

2 PACE-D Technical Assistance Program Financing Renewable Energy in India 3 burden of payments for GBI7 on the government. The U.S. has a long track record in tradable certificates. India also had tradable duty-free import credits, which were very popular with exporters. 1 Potential for RE in India Policy Instruments

• REC Market Maker: The establishment of an “REC Market Maker” would address the current lack of “bankability” of RECs. It would be a government-sponsored body that would 1.1 CURRENT SCENARIO act as a buyer and seller of last resort, in case of either oversupply or shortage of RECs in India's current installed capacity of RE stands at 29,812 MW.8 This includes 28,905 MW of grid- the market. connected RE and 96.8 MW of off-grid capacity. According to the 12th Five Year Plan of the Planning Financial Instruments Commission, the country aims to add 30,000 MW of RE capacity during the 12th Five Year Plan th • Green Bonds: Green bonds, or climate bonds, are asset-backed bonds that allow refinancing Period (2012 - 2017) and about 45,000 MW of RE capacity during the 13 Five Year Plan Period (2017- of RE projects and thus increase liquidity. While they are popular in developed markets, 2022) (GOI, 2013). The Jawaharlal Nehru National Solar Mission (JNNSM) under the National Action especially Europe, the U.S. and China, they have not yet been used in India. Plan on Climate Change (NAPCC) targets addition of more than 20,000 MW of solar capacity by 2022.9 • Infrastructure Debt Funds: Infrastructure Debt Funds (IDFs) allow tapping of long-term, low- cost debt from insurance and pension funds (both domestic and foreign) to refinance bank 1.2 POTENTIAL OF RE debt of infrastructure projects. This structure, introduced in India in 2011, has so far not been used for RE projects. India has abundant RE resources (wind, solar, biomass and hydro) that can be harnessed to generate • Off-Grid Fund: An off-grid fund financed by high-net-worth individuals (HNIs) and corporate substantial amounts of electricity (See Figure 1: Potential vs. Installed Capacity of RE in India) across social responsibility (CSR) sources could be used to support competent RESCOs for the various geographical regions of the country. development of commercial and rural off-grid projects, with a dual focus on financial returns and social impact. • Risk Insurance Instruments: Insurance instruments can be designed to cover the various risks faced by RE projects, such as resource, technology, off-taker, power purchase agreement, and project development risks. These instruments can attract large-scale, risk- averse, investors and lenders to the sector. These seven financial mechanisms can spur RE investment by catalyzing new sources of financing such as pension funds, sovereign wealth funds, insurance companies, CSR and HNI funds. They can also facilitate refinancing of debt with longer tenure and lower-cost funds; provide wider access to tax benefits, thereby expanding the pool of investors; and reduce project risks through insurance products. This report describes in more detail how each of these instruments operate and how they can be adapted and implemented in order to help address the current barriers to RE finance in India.

7 GBI was introduced as an alternative incentive mechanism to accelerated depreciation for IPPs, because IPPs were unable to generate adequate profits to take advantage of the entire accelerated depreciation benefit. If tradable tax credits are introduced, IPPs can use these credits thereby removing the need for a 8 Available at http://www.mnre.gov.in/mission-and-vision-2/achievements/, last accessed on September 13, 2013 separate incentive mechanism like GBI. 9 Available at http://www.mnre.gov.in/solar-mission/jnnsm/introduction-2/, last accessed on September 13, 2013

4 PACE-D Technical Assistance Program Financing Renewable Energy in India 5 burden of payments for GBI7 on the government. The U.S. has a long track record in tradable certificates. India also had tradable duty-free import credits, which were very popular with exporters. 1 Potential for RE in India Policy Instruments

4 PACE-D Technical Assistance Program Financing Renewable Energy in India 5 Solar and wind are the largest RE resources available in India. India receives high solar radiation and MNRE estimates surplus biomass availability of about 120-150 million metric tons per annum from has on an average 300 sunny days per year. The Bangalore based Indian Institute of Science (IISc) agricultural and forestry residues in India with which about 18 GW of electrical and/or thermal (Ramachandra, et. al, 2011) estimates that nearly 58 percent of the country's total area receives capacity can be developed. An additional 5 GW of biomass capacity can also be harnessed from 14 more than 5 kWh/sq m/day of annual average Global Horizontal Irradiance (GHI)10. At this level of bagasse generated in nearly 550 sugar mills across the country. solar radiation, solar photovoltaic (PV) plants can achieve capacity utilization factors between 17 and MNRE has identified 5,415 potential sites for small and mini hydro projects, which have a potential 22 percent. If even one percent of the land area were to be used for solar projects; nearly 1,460 GW of 14 GW.15 However, the actual potential could be much higher as the potential site identification of solar PV capacity could be installed. process is still on-going across the country.

11 Figure 1: Potential vs. Installed Capacity of RE in India 1.3 DRIVERS OF RE INVESTMENT The main drivers of RE investment in India include: 2000 • Technology: Technological advancements have led to improved conversion efficiencies and lowered capital costs for RE technologies (RETs). These advancements will continue to Potential (GW) move RE technologies closer towards grid parity16. Hence, they are among the main drivers 1500 2000 Installed Capacity for investment in this sector. Key RETs, such as small hydro, wind and biomass, are already (GW) close to grid parity. It is expected that RETs are likely to achieve grid parity and become 1460 more competitive vis-à-vis conventional power technologies due to increasing supply 1000 ~ ~ constraints for key fossil fuels and their escalating costs. 30 23 19.6 • Energy Scarcity: In spite of being among the top five global countries in terms of power 20 14 generation and installed capacity, India has average and peak energy deficits as high as 8.7 10 1.9 4.2 3.7 percent and 9.0 percent respectively for FY 2012-13 as per Central Electricity Authority (CEA) 0 estimates. One of the key factors for such high energy deficits is the enormous bottleneck in Solar Wind Biomass Small Hydro the coal supply chain. Most power plants in India today are running below their expected plant load factors (PLFs) due to limited access to coal supplies. Energy scarcity is not only The Centre for Wind Energy Technology, an autonomous research and development institution under reflected in poor access to electricity for rural areas but also in regular power outages in urban and semi urban areas and commercial and industrial (C&I) units. C&I units in turn are Ministry of New and Renewable Energy (MNRE), has estimated India's wind potential at 102.8 GW increasingly using diesel as an alternative source of energy to overcome energy scarcity. (at 80m hub height).12 However, a number of other estimates made in the recent past indicate that This is both un-economical and creates significant environmental challenges. India's the potential is higher. For example, U.S.-based Lawrence Berkeley National Laboratory, under a abundant RE resources, therefore, offer an alternative source of clean energy that can help recent study (LBNL, 2011) estimated that about seven percent of land area in India (i.e., 281,432 sq overcome the country's energy scarcity.17 km) has over 200 W/sq m of wind power density (at 80m hub height).13 At this density, about 2,000 • Energy Security: Nearly 70 percent of India's electricity generation comes from fossil fuels, GW of wind capacity could be developed across the states of Andhra Pradesh, Karnataka, with coal being the mainstay of India's energy generation. A significant increase in energy Maharashtra, Tamil Nadu and Gujarat. demand is projected with economic growth and social development, which in turn will

10 Global Horizontal Irradiance (GHI) is the amount of terrestrial irradiance falling on a surface horizontal to the 14 Available at http://mnre.gov.in/schemes/grid-connected/biomass-powercogen/, last accessed on September surface of the earth. 13, 2013 11 Source: Installed Capacity: MNRE estimates, Potential Capacity: IISc estimates for solar, Lawrence Berkeley 15 Available at http://mnre.gov.in/schemes/grid-connected/small-hydro/, lastaccessed on September 13, 2013 National Laboratory for wind, MNRE for biomass and small hydro 16 Grid parity is the point at which alternative means of generating electricity are equal in cost to, or cheaper 12 Available at http://www.cwet.tn.nic.in/html/departments_ewpp.html, last accessed on September 13, 2013 than, grid power. 13 At higher hub heights, land area receiving over 200 m/sec wind speed increases. 13 percent of land area 17 For 2010-11, while 339,878 GWh of the electricity consumed by C&I units were supplied by utilities and receives over 200 m/sec wind speed at 120 m hub height captive generation units, commercial sector has used diesel for generating over 51,000 GWh to meet energy scarcity.

6 PACE-D Technical Assistance Program Financing Renewable Energy in India 7 Solar and wind are the largest RE resources available in India. India receives high solar radiation and MNRE estimates surplus biomass availability of about 120-150 million metric tons per annum from has on an average 300 sunny days per year. The Bangalore based Indian Institute of Science (IISc) agricultural and forestry residues in India with which about 18 GW of electrical and/or thermal (Ramachandra, et. al, 2011) estimates that nearly 58 percent of the country's total area receives capacity can be developed. An additional 5 GW of biomass capacity can also be harnessed from 14 more than 5 kWh/sq m/day of annual average Global Horizontal Irradiance (GHI)10. At this level of bagasse generated in nearly 550 sugar mills across the country. solar radiation, solar photovoltaic (PV) plants can achieve capacity utilization factors between 17 and MNRE has identified 5,415 potential sites for small and mini hydro projects, which have a potential 22 percent. If even one percent of the land area were to be used for solar projects; nearly 1,460 GW of 14 GW.15 However, the actual potential could be much higher as the potential site identification of solar PV capacity could be installed. process is still on-going across the country.

6 PACE-D Technical Assistance Program Financing Renewable Energy in India 7 increase the demand for coal. Indigenous coal is not adequate to meet the country's increasing demands, so coal is being imported in large quantities. In spite of being the third largest steam coal producer in the world (producing 504 million metric tons (MMT) of coal in 2012), India is also the fourth largest importer of steam coal. The dependence on steam coal imports for electricity 2 Policy Support for RE in India generation has grown at an alarming rate from 22 MMT in 2006 (five percent of the total requirement) to 123 MMT in 2012 (24 percent of the total requirement).18 The demand and supply gap for coal is expected to rise to 266 MMT by FY 2016-1719, which is likely to have a significant Government interventions remain the backbone of RE market development across the globe. A impact on the availability and pricing of international coal, thereby aggravating the current account review of policies and regulatory frameworks across countries indicates that commercialization of deficit problems in India. To counter the potential adverse impacts from the import of large RETs remains dependent on government support, be it in the form of fiscal support or other support quantities of coal, the GOI is strategically moving the country's energy mix to RE and nuclear like favourable access to the grid. International experience is replete with successful examples of energy for improved energy security in the future. governments leveraging these instruments to scale up RE deployment. Some of the most • Climate Change: Concern about climate change mitigation is growing across the globe. Low successful examples are Germany (soft loans for residential solar photovoltaic systems and FiTs for emission development strategies and related policy measures are being developed by a large wind and solar); Japan (net metering, grants for demonstration projects, and subsidy for de- number of countries. For its part, India has adopted the NAPCC in 2008. The NAPCC is being centralized residential solar photovoltaic systems); California, U.S. (production and investments tax implemented through eight National Missions which aim at achieving sustainable development, credits, net metering, renewable portfolio standard for states, and FiTs for all RETs), Texas, U.S. (RE by integrating the need for economic growth with the need to address environmental concerns. purchase targets); and Spain (high FiTs for solar). Availability of suitable policy instruments provides The National Solar Mission, one of the key missions under the NAPCC, aims to add 20 GW of the right incentives for the development of RE with the view of ensuring greater long term adoption solar power capacity by 2022 and facilitate the development of an eco-system for solar energy and global cost competitiveness. development in India (NAPCC, 2008). India has been at the forefront of RE development due to its proactive policy and regulatory • Energy Access: India is still quite far from achieving universal access to electricity. The GOI's frameworks. India has successfully designed and launched a number of policy instruments which targets of providing rural electricity access to all villages by 2009 and universal household access have enhanced the viability and bankability of RE projects. The use of these instruments at the state by 2012 have not been met. As of 2011, 57 percent of rural households used electricity as their and the central levels has allowed large scale deployment of RE and development of new business main source of lighting (up from 45 percent in 2001).20 Off-grid RETs offer one of the most reliable models across the country. The key policy instruments for promotion of RE include: tax incentives, and cost effective options for the delivery of clean energy services, especially for rural areas. The FiTs, subsidies, RECs, and GBI. However, India's experience with such instruments has not been Smart Grid Vision and Roadmap for India sets a target of achieving universal access to electricity by 2017. without challenges: the design and implementation of these instruments has often been hampered • RE Purchase Obligations: NAPCC targets 15 percent RE adoption by FY 2021-22 (NAPCC, 2008). RPOs have been mandated by the Electricity Act 2003 as a mechanism to ensure greater adoption of RE. To comply with this, each State Electricity Regulatory Commission (SERC) has mandated a RPO target for distribution companies and other obligated entities in the state. These targets vary across states (between 0.5 to 10 percent of the total energy distributed by these utilities) and are meant to increase over time. The Amendment to National Tariff Policy in 2011 has also announced specific targets for solar power consumption – starting from 0.25 percent in FY 2012-13 and going up to three percent in FY 2021-22.21 The national, state and the solar RPO targets shall drive demand for RE technologies over the next decade in the country.

18 Available at http://www.worldcoal.org/resources/coal-statistics/, last accessed on September 13, 2013 19 Available at http://zeenews.india.com/business/news/companies/coal-demand-supply-gap-likely-to-touch-266- mt-by-fy17-imacs_70243.html, last accessed on September 13, 2013 20 Available at http://www.censusindia.gov.in/2011census/hlo/Data_sheet/India/Source_Lighting.pdf, last accessed on September 13, 2013 21 Available at http://pib.nic.in/newsite/erelease.aspx?relid=68902, last accessed on September 13, 2013

8 PACE-D Technical Assistance Program Financing Renewable Energy in India 9 increase the demand for coal. Indigenous coal is not adequate to meet the country's increasing demands, so coal is being imported in large quantities. In spite of being the third largest steam coal producer in the world (producing 504 million metric tons (MMT) of coal in 2012), India is also the fourth largest importer of steam coal. The dependence on steam coal imports for electricity 2 Policy Support for RE in India generation has grown at an alarming rate from 22 MMT in 2006 (five percent of the total requirement) to 123 MMT in 2012 (24 percent of the total requirement).18 The demand and supply gap for coal is expected to rise to 266 MMT by FY 2016-1719, which is likely to have a significant Government interventions remain the backbone of RE market development across the globe. A impact on the availability and pricing of international coal, thereby aggravating the current account review of policies and regulatory frameworks across countries indicates that commercialization of deficit problems in India. To counter the potential adverse impacts from the import of large RETs remains dependent on government support, be it in the form of fiscal support or other support quantities of coal, the GOI is strategically moving the country's energy mix to RE and nuclear like favourable access to the grid. International experience is replete with successful examples of energy for improved energy security in the future. governments leveraging these instruments to scale up RE deployment. Some of the most • Climate Change: Concern about climate change mitigation is growing across the globe. Low successful examples are Germany (soft loans for residential solar photovoltaic systems and FiTs for emission development strategies and related policy measures are being developed by a large wind and solar); Japan (net metering, grants for demonstration projects, and subsidy for de- number of countries. For its part, India has adopted the NAPCC in 2008. The NAPCC is being centralized residential solar photovoltaic systems); California, U.S. (production and investments tax implemented through eight National Missions which aim at achieving sustainable development, credits, net metering, renewable portfolio standard for states, and FiTs for all RETs), Texas, U.S. (RE by integrating the need for economic growth with the need to address environmental concerns. purchase targets); and Spain (high FiTs for solar). Availability of suitable policy instruments provides The National Solar Mission, one of the key missions under the NAPCC, aims to add 20 GW of the right incentives for the development of RE with the view of ensuring greater long term adoption solar power capacity by 2022 and facilitate the development of an eco-system for solar energy and global cost competitiveness. development in India (NAPCC, 2008). India has been at the forefront of RE development due to its proactive policy and regulatory • Energy Access: India is still quite far from achieving universal access to electricity. The GOI's frameworks. India has successfully designed and launched a number of policy instruments which targets of providing rural electricity access to all villages by 2009 and universal household access have enhanced the viability and bankability of RE projects. The use of these instruments at the state by 2012 have not been met. As of 2011, 57 percent of rural households used electricity as their and the central levels has allowed large scale deployment of RE and development of new business main source of lighting (up from 45 percent in 2001).20 Off-grid RETs offer one of the most reliable models across the country. The key policy instruments for promotion of RE include: tax incentives, and cost effective options for the delivery of clean energy services, especially for rural areas. The FiTs, subsidies, RECs, and GBI. However, India's experience with such instruments has not been Smart Grid Vision and Roadmap for India sets a target of achieving universal access to electricity by 2017. without challenges: the design and implementation of these instruments has often been hampered • RE Purchase Obligations: NAPCC targets 15 percent RE adoption by FY 2021-22 (NAPCC, 2008). RPOs have been mandated by the Electricity Act 2003 as a mechanism to ensure greater adoption of RE. To comply with this, each State Electricity Regulatory Commission (SERC) has mandated a RPO target for distribution companies and other obligated entities in the state. These targets vary across states (between 0.5 to 10 percent of the total energy distributed by these utilities) and are meant to increase over time. The Amendment to National Tariff Policy in 2011 has also announced specific targets for solar power consumption – starting from 0.25 percent in FY 2012-13 and going up to three percent in FY 2021-22.21 The national, state and the solar RPO targets shall drive demand for RE technologies over the next decade in the country.

8 PACE-D Technical Assistance Program Financing Renewable Energy in India 9 and production companies in the first year of operation.26 Thus, non-wind RE assets and wind assets by uncertainty on continuity and frequent revisions. This section of the report identifies some of can be depreciated 100 percent and 35 percent respectively in the first year. these instruments, describes their design, use and the constraints which have been limiting their effectiveness. The accelerated depreciation benefit has been a very effective tool for mobilizing funds for RE technologies like wind. The accelerated depreciation benefit was initially available for wind energy 2.1 TAX INCENTIVES projects and was the key driver for capacity addition in the country's wind sector. However, the benefit was withdrawn in April 2012. This withdrawal negatively impacted the growth of wind 2.1.1 Income Tax Exemption capacity. For instance, during the FY 2012-13, only 1,700 MW of wind power capacity was added as compared to 3,164 MW in the previous financial year.27 All companies in India are required to pay taxes on their profits. As per Income Tax Law, the For a long time, wind energy was the preferred RE technology to avail tax benefits due to its 22 corporate tax rate is 32.45 percent for income below INR 100 million (USD 1.6 million) and 33.99 simplicity in operation; no fuel requirement; mature technology; end-to-end turnkey project 23 percent for incomes above INR 100 million (USD 1.6 million). The GOI, under Section 80-IA of development by equipment suppliers; low operations and maintenance (O&M) costs; encouraging Income Tax Law Act, 1961 (IT Law), exempts all infrastructure assets (this includes RE generators) policy framework; short implementation period (within one year); and ease of capacity expansion. from income tax for a block of any 10 consecutive years out of the first fifteen years of operation. Unlike wind, the other three RETs (biomass, hydro and solar) suffer from a number of issues which (See Box 1: Challenges in the Implementation of Income Tax Exemptions) make them unattractive to investors for tax saving purposes:

Box 1: Challenges in the Implementation of Income Tax Exemptions • Biomass projects have significant fuel availability and price risks. • Small hydro projects have difficulties in obtaining clearances, and require long development During the income tax exemption period, companies have to pay a minimum alternate tax (MAT) of time (two-three years) and implementation time (three years). 20.01 percent on profits if their income is below INR 100 million (USD 1.6 million) and 20.96 percent if their income is above INR 100 million (USD 1.6 million).24 Thus, infrastructure assets do not get a • Solar projects lack attractive FiTs; however of all the three technologies, solar has the clean “exemption” on income tax, but only a discount (as they have to bear the lower MAT rate highest potential to leverage this tax benefit. instead of the corporate tax rate) or deferment. The amount of MAT paid during a year of exemption Tax savings due to accelerated depreciation are 32.45 percent (if income is below INR 100 million) or contributes towards MAT credits which may be used for setting off income tax liabilities in the 33.99 percent (if income is above INR 100 million) of the capital cost during the first year. (See Box subsequent 10 years. 2: Limitations of Accelerated Depreciation)

2.1.2 Accelerated Depreciation Box 2: Limitations of Accelerated Depreciation In order to promote RE, the GOI provides a higher depreciation rate (80 percent for plant and RE projects are capital intensive, with low taxable profits in the initial years due to high depreciation. machinery) for non-wind RE projects vis-a-vis 7.84 percent for thermal power plants and 15 percent Hence, the benefit of accelerated depreciation can only be utilized when the company owning the RE for other power equipment.25 An additional 20 percent depreciation is available for all manufacturing asset generates enough profits from other businesses. Independent Power Producers (IPP)s, which are the key drivers of investments in RE, suffer as a result because they invest via SPVs in each 22 Income tax rate 30 percent + Surcharge 5 percent + Education Cess 3 percent. project. SPVs have low profitability in the initial years and cannot benefit from high depreciation 23 Available at http://law.incometaxindia.gov.in/DIT/File_opener.aspx?page=FINA&schT=FIN&csId=30d194ca- levels. Captive generators, with high profitability in their parent businesses enjoy significant afe8-4ed5-afc6-f7c6d83451eb&&pId=9c845744-9bd9-4c83-aa3a-f3cb1dcd62f7&sch=&title=Taxmann20- advantage while investing in RE, vis-à-vis IPPs. These tax benefits are not transferable in any form. 20Direct20Tax20Laws , last accessed on September 13, 2013 24 MAT Rate 18.5 + Surcharge 5 + Education Cess 3. Available at 26 http://law.incometaxindia.gov.in/DIT/File_opener.aspx?page=ITAC&schT=&csId=6f08213f-bec8-4d1c-b232- Available at 45979fb9093a&rdb=sec&yr=a56ea192-3ca8-433a-a515-ed68a062eac7&sec=&sch=&title=Taxmann20- http://law.incometaxindia.gov.in/DIT/HtmlFileProcess.aspx?FooterPath=D:5CWebSites5CDITTaxmann5CAct20 20Direct20Tax20Laws, last accessed on September 13, 2013 105CDirectTaxLaws5CITACT5CHTMLFiles5C2010&DFile=section80ia.htm&tar=top, last accessed on September 13, 2013 25 Available at http://law.incometaxindia.gov.in/DIT/File_opener.aspx?page=ITRU&schT=rul&csId=4a23cee1- 27 1818-45d6-ab19-f155e08ed789&rNo=&sch=&title=Taxmann20-20Direct20Tax20Laws, last accessed on Available at http://mnre.gov.in/file-manager/UserFiles/wp_installed.htm, last accessed on September 13, 2013 September 13, 2013

10 PACE-D Technical Assistance Program Financing Renewable Energy in India 11 and production companies in the first year of operation.26 Thus, non-wind RE assets and wind assets by uncertainty on continuity and frequent revisions. This section of the report identifies some of can be depreciated 100 percent and 35 percent respectively in the first year. these instruments, describes their design, use and the constraints which have been limiting their effectiveness. The accelerated depreciation benefit has been a very effective tool for mobilizing funds for RE technologies like wind. The accelerated depreciation benefit was initially available for wind energy 2.1 TAX INCENTIVES projects and was the key driver for capacity addition in the country's wind sector. However, the benefit was withdrawn in April 2012. This withdrawal negatively impacted the growth of wind 2.1.1 Income Tax Exemption capacity. For instance, during the FY 2012-13, only 1,700 MW of wind power capacity was added as compared to 3,164 MW in the previous financial year.27 All companies in India are required to pay taxes on their profits. As per Income Tax Law, the For a long time, wind energy was the preferred RE technology to avail tax benefits due to its 22 corporate tax rate is 32.45 percent for income below INR 100 million (USD 1.6 million) and 33.99 simplicity in operation; no fuel requirement; mature technology; end-to-end turnkey project 23 percent for incomes above INR 100 million (USD 1.6 million). The GOI, under Section 80-IA of development by equipment suppliers; low operations and maintenance (O&M) costs; encouraging Income Tax Law Act, 1961 (IT Law), exempts all infrastructure assets (this includes RE generators) policy framework; short implementation period (within one year); and ease of capacity expansion. from income tax for a block of any 10 consecutive years out of the first fifteen years of operation. Unlike wind, the other three RETs (biomass, hydro and solar) suffer from a number of issues which (See Box 1: Challenges in the Implementation of Income Tax Exemptions) make them unattractive to investors for tax saving purposes:

10 PACE-D Technical Assistance Program Financing Renewable Energy in India 11 2.2 FEED-IN TARIFFS Box 3: Limitations of Feed-in-Tariffs The FiT is one of the most successful and effective instruments, used across the globe for One of the most successful policy instruments for promoting RE has been the FiT. State promoting RE generation. However, feed-in tariffs have to be designed carefully keeping in governments across the country have been providing long term support to RE through FiTs, also perspective the prevailing market conditions. If the FiT is too high it leads to huge unwarranted known as preferential tariffs. Under the FiT framework, RE power is procured by Distribution profits for the developers and high costs for consumers, while if it is too low, it can lead to very low Companies (DISCOMs) at the FiT specified by SERCs. FiTs, applicable over a period of 10 to 25 financial returns leading to low investments in the sector. The other challenge lies in adjusting the FiTs, as experience is gained, technology improves and costs fall. This instrument may also lead to years, ensure predictable financial returns over the life of the project. The SERCs determine FiTs for concentration of projects in regions with better FiTs. each RE technology (separately) using a cost plus approach based on following factors: In India, the FiTs are determined by the SERCs on a year-by-year basis. SERCs sometimes do not have the appropriate analytical tools, databases and sector experts needed to undertake an • Achievable capacity utilization factors based on the availability of fuel/resource; appropriate market analysis and capture prevailing market costs or adjust FiTs based on resource • Operating costs (cost of fuel, O&M expenses, capital replacement); quality. For example, the state of Tamil Nadu announced a preferential tariff of INR 3.51 per kWh31 • Capital expenditure (project cost); (U.S. cents 5.6 per kWh) for wind energy projects across wind zones. Projects availing this tariff and selling it to the state distribution company are only able to generate low equity returns in the range • Share of debt and the cost of debt; and of 10 to 12 percent. On the other hand the state of Madhya Pradesh has attracted many investors • Expected return on equity. due to its attractive FiT at INR 5.92 per kWh32 (U.S. cents 9.5 per kWh). There is a need for a consistent approach to determining FiTs across states based on up-to-date For established technologies, such as solar, wind, hydro and biomass, SERCs benchmark costs investment and operating costs, the maturity of technology and quality of RE resource. associated with setting up and operating a project. They hold consultation with various stakeholders and then notify tariffs28 for each RE technology based on the benchmarked costs. Based on the 2.3. RENEWABLE ENERGY PURCHASE OBLIGATIONS nature of the technology, FiTs may have fixed and variable components29. (See Box 3: Limitations of RPOs stimulate demand for RE by providing a guaranteed market for RE power. RPOs in India have Feed-in-Tariff) been mandated by the Electricity Act, 2003 (GOI, 2003) and the National Tariff Policy, 2011 (GOI, Reverse Bidding 2011a). RPO targets are defined as a percentage of the total power consumed or distributed by the obligated entities, which include any of the following groups of entities: JNNSM Phase 1, in 2010, was the first solar program to use a reverse bidding process for tariff • Distribution companies discovery and project allotment. In a reverse bidding process, projects are allocated to developers • Captive power consumers who either quote the lowest tariff, or provide the maximum discount on the benchmark tariff. The • Open access consumers reverse bidding process has resulted in a reduction of solar tariff from INR 17.91 per kWh (U.S. cents 28.6 per kWh) to INR 10.95 per kWh (U.S. cents 17.5 per kWh) (GOI, 2012). The reverse bidding These obligated entities can meet their RPO targets either by generating renewable power from process benefited from falling technology costs. The success of JNNSM Phase I in reducing solar captive sources; purchasing renewable power; and/or purchasing RECs. If obligated entities are tariffs encouraged several other state solar programs to adopt this process and resulted in further unable to meet their RPO targets through either of the above mentioned means, they face a penalty reduction of tariffs to INR 5.51 per kWh30 (U.S. cents 8.8 per kWh) by 2013. These programs are for non-compliance equivalent to the forbearance price of RECs33. The obligated entities need to summarized in Annex A. meet their RPO targets before the end of each financial year.

28 Tariffs differ for developers that avail accelerated depreciation benefit and those who do not avail such a 31 Available at benefit http://tnerc.tn.nic.in/orders/Tariff%20Order%202009/2012/T.R%20No.6%20of%202012%20dated%2031-07- 29 The fixed component, which is based on capital expenditure and other fixed costs, remains constant for the 2012-Wind.pdf, last accessed on September 13, 2013 entire life of the project. For technologies like solar, wind, small hydro where there are no variable operating 32 Available at http://www.mperc.nic.in/26032013-Wind-tariff-order.pdf, last accessed on September 13, 2013 expenses, the tariff includes the fixed component only. The variable component, which is based on operating 33 Forbearance price means the ceiling price as determined by CERC. Forbearance price for solar RECs and non expenses like fuel, is revised on a regular basis. solar RECs is INR 13,400 per MWh (USD 214.1 per MWh) and INR 3,300 per MWh (USD 53.7 per MWh) 30 Available at http://kredlinfo.in/Financial%20Bid%20results%20on%2026.03.2013.pdf, last accessed on respectively. Order by CERC is available at September 13, 2013 https://www.recregistryindia.nic.in/pdf/REC_Regulation/Order_on_Forbearnace__Floor_Price_23-8-2011.pdf, last accessed on September 13, 2013.

12 PACE-D Technical Assistance Program Financing Renewable Energy in India 13 2.2 FEED-IN TARIFFS Box 3: Limitations of Feed-in-Tariffs The FiT is one of the most successful and effective instruments, used across the globe for One of the most successful policy instruments for promoting RE has been the FiT. State promoting RE generation. However, feed-in tariffs have to be designed carefully keeping in governments across the country have been providing long term support to RE through FiTs, also perspective the prevailing market conditions. If the FiT is too high it leads to huge unwarranted known as preferential tariffs. Under the FiT framework, RE power is procured by Distribution profits for the developers and high costs for consumers, while if it is too low, it can lead to very low Companies (DISCOMs) at the FiT specified by SERCs. FiTs, applicable over a period of 10 to 25 financial returns leading to low investments in the sector. The other challenge lies in adjusting the FiTs, as experience is gained, technology improves and costs fall. This instrument may also lead to years, ensure predictable financial returns over the life of the project. The SERCs determine FiTs for concentration of projects in regions with better FiTs. each RE technology (separately) using a cost plus approach based on following factors: In India, the FiTs are determined by the SERCs on a year-by-year basis. SERCs sometimes do not have the appropriate analytical tools, databases and sector experts needed to undertake an • Achievable capacity utilization factors based on the availability of fuel/resource; appropriate market analysis and capture prevailing market costs or adjust FiTs based on resource • Operating costs (cost of fuel, O&M expenses, capital replacement); quality. For example, the state of Tamil Nadu announced a preferential tariff of INR 3.51 per kWh31 • Capital expenditure (project cost); (U.S. cents 5.6 per kWh) for wind energy projects across wind zones. Projects availing this tariff and selling it to the state distribution company are only able to generate low equity returns in the range • Share of debt and the cost of debt; and of 10 to 12 percent. On the other hand the state of Madhya Pradesh has attracted many investors • Expected return on equity. due to its attractive FiT at INR 5.92 per kWh32 (U.S. cents 9.5 per kWh). There is a need for a consistent approach to determining FiTs across states based on up-to-date For established technologies, such as solar, wind, hydro and biomass, SERCs benchmark costs investment and operating costs, the maturity of technology and quality of RE resource. associated with setting up and operating a project. They hold consultation with various stakeholders and then notify tariffs28 for each RE technology based on the benchmarked costs. Based on the 2.3. RENEWABLE ENERGY PURCHASE OBLIGATIONS nature of the technology, FiTs may have fixed and variable components29. (See Box 3: Limitations of RPOs stimulate demand for RE by providing a guaranteed market for RE power. RPOs in India have Feed-in-Tariff) been mandated by the Electricity Act, 2003 (GOI, 2003) and the National Tariff Policy, 2011 (GOI, Reverse Bidding 2011a). RPO targets are defined as a percentage of the total power consumed or distributed by the obligated entities, which include any of the following groups of entities: JNNSM Phase 1, in 2010, was the first solar program to use a reverse bidding process for tariff • Distribution companies discovery and project allotment. In a reverse bidding process, projects are allocated to developers • Captive power consumers who either quote the lowest tariff, or provide the maximum discount on the benchmark tariff. The • Open access consumers reverse bidding process has resulted in a reduction of solar tariff from INR 17.91 per kWh (U.S. cents 28.6 per kWh) to INR 10.95 per kWh (U.S. cents 17.5 per kWh) (GOI, 2012). The reverse bidding These obligated entities can meet their RPO targets either by generating renewable power from process benefited from falling technology costs. The success of JNNSM Phase I in reducing solar captive sources; purchasing renewable power; and/or purchasing RECs. If obligated entities are tariffs encouraged several other state solar programs to adopt this process and resulted in further unable to meet their RPO targets through either of the above mentioned means, they face a penalty reduction of tariffs to INR 5.51 per kWh30 (U.S. cents 8.8 per kWh) by 2013. These programs are for non-compliance equivalent to the forbearance price of RECs33. The obligated entities need to summarized in Annex A. meet their RPO targets before the end of each financial year.

12 PACE-D Technical Assistance Program Financing Renewable Energy in India 13 However there is a lack of consistency in the methodology used for determining RPO targets for a Box 4: Limitations of RECs state. As a result, the RPO targets set by the states vary substantially, ranging from one percent in Poor enforcement of RPOs: The lack of enforcement is leading to low REC price and over supply. The Tripura to 10.25 percent in Himachal Pradesh.34 RPO targets have been adopted by most states but build-up of unsold RECs in the last few months is a big cause of concern for both generators and met by the obligated entities in only a handful of states. Penalty enforcement has been hindered banks. because state utilities have poor financial health. So far, none of these entities have been penalized for non-compliance. Also, a proper monitoring system for tracking achievements vis-à-vis the RPO Unpredictable cash flows to generators: Obligated entities are mandated to meet their annual RPO targets by the end of each financial year. Thus, most obligated entities defer the purchase of RECs targets has not been established. towards the end of the year. This delay significantly impacts the predictability and uniformity of cash 2.4 RENEWABLE ENERGY CERTIFICATES flows for the generators, and thus, their ability to raise finance on attractive terms. This can also lead to working capital problems for the generators.

The Central Electricity Regulatory Commission (CERC) has included the purchase of RECs as one of High price for solar RECs: In August 2011, CERC announced floor prices and forbearance prices for the ways of meeting the RPOs (GOI, 2010a). The REC program aims to provide market based solar and non-solar RECs for the trading period April 2012 to March 2017. Since then, the capital cost incentives for RE developers and distribute the marginal cost of RE deployment nationwide. The REC of solar projects has decreased dramatically due to a global oversupply of solar modules. For instance, in the recently concluded solar capacity allotment through reverse bidding process in program has two objectives: to facilitate achievement of RPO targets for obligated entities not able to Karnataka, the lowest bid was INR 5.51 per kWh (U.S. cent 8.8 per kWh). Thus, the floor price for invest in RE; and to facilitate creation of RE capacities in regions with the least cost of generation and solar RECs at INR 9,300 per MWh (USD 148.6 per MWh) i.e., INR 9.3 per kWh (USD 1.49 per kWh), abundant RE resources. is higher than the tariff discovered through competitive bidding. This mismatch has led to uncertainty regarding the continuation of the floor and forbearance price, thereby, making it difficult for projects CERC, through the REC framework, has bifurcated the electricity and renewable components of RE. based on solar RECs to raise finance. Power generators can sell electricity and RECs to two distinct users. Projects availing REC benefits No price certainty post 2017: The CERC has announced floor prices and forbearance prices for RECs cannot take advantage of any of the preferential benefits (concessional wheeling charges, banking only until 2017. This has led to uncertainty regarding revenues from RECs beyond this time frame. facility, electricity duty waiver, or sale of power to DISCOM at FiTs). The projects availing RECs can This makes it difficult for FIs to lend to projects based on RECs because such loans normally extend sell power under open access to third party or group captive customers or sell power to distribution beyond 10 years. companies at the average pooled purchase cost (APPC). RECs not available for off-grid projects: As per the current guidelines, RECs are only allowed for grid- connected plants. There are no alternate guidelines under REC mechanism for small RE capacities Projects must also be connected to the grid in order to be eligible for RECs. One REC is equivalent to developed for off-grid rural or onsite captive consumption. 1 MWh of renewable power generated, and is valid for a period of two years from the date of issuance.35 These certificates can be bought and sold through two designated exchanges, i.e., India Design constraints for RECs: A number of design constraints have also limited the tradability of Energy Exchange and Power Exchange of India. Only eligible generating entities are allowed to sell RECs. These include disallowing forward contracting/bilateral trades of RECs; lack of an over-the- and purchase RECs. The RECs cannot be resold and, once traded, can only be used by the buyer for counter market (intermediaries are not allowed to trade RECs); and expiry of unsold RECs after two years. meeting its RPO target. CERC has established a trading range for solar and non-solar RECs by setting a floor price36 and a forbearance price. These prices are determined based on the difference between the marginal cost of generation from RE and conventional sources. (See Box 4: Limitations of RECs) 2.5 SUBSIDIES 34 Available at http://ceew.in/pdf/Appendix_F-Renewable_Purchase_Obligation_for_States.pdf, last accessed on September 13, 2013 2.5.1 Grid-connected RE 35 Shelf life revised to two years in February 2013. Order by CERC is available at https://www.recregistryindia.nic.in/pdf/REC_Regulation/CERC_Order_dated_11.02_.2013_.pdf, last accessed MNRE and several state governments, support the development of grid-connected RE through the on September 13, 2013 provision of subsidies. For example, for biomass based RE projects, MNRE provides a subsidy of up 36 Floor price for solar RECs and non solar RECs is INR 9,300 per MWhr (USD 148.6 per MWhr) and INR 1,500 to INR 2.5 million per MW (USD 40,000 per MW) to special category states, and up to INR 2 million per MWhr (USD 23.9 per MWhr) respectively. Order by CERC is available at https://www.recregistryindia.nic.in/pdf/REC_Regulation/Order_on_Forbearnace__Floor_Price_23-8-2011.pdf, last accessed on September 13, 2013.

14 PACE-D Technical Assistance Program Financing Renewable Energy in India 15 However there is a lack of consistency in the methodology used for determining RPO targets for a Box 4: Limitations of RECs state. As a result, the RPO targets set by the states vary substantially, ranging from one percent in Poor enforcement of RPOs: The lack of enforcement is leading to low REC price and over supply. The Tripura to 10.25 percent in Himachal Pradesh.34 RPO targets have been adopted by most states but build-up of unsold RECs in the last few months is a big cause of concern for both generators and met by the obligated entities in only a handful of states. Penalty enforcement has been hindered banks. because state utilities have poor financial health. So far, none of these entities have been penalized for non-compliance. Also, a proper monitoring system for tracking achievements vis-à-vis the RPO Unpredictable cash flows to generators: Obligated entities are mandated to meet their annual RPO targets by the end of each financial year. Thus, most obligated entities defer the purchase of RECs targets has not been established. towards the end of the year. This delay significantly impacts the predictability and uniformity of cash 2.4 RENEWABLE ENERGY CERTIFICATES flows for the generators, and thus, their ability to raise finance on attractive terms. This can also lead to working capital problems for the generators.

14 PACE-D Technical Assistance Program Financing Renewable Energy in India 15 40 per MW (USD 32,000 per MW) in the rest of India. Some states, such as Bihar, also provide a capital • Interest Subsidy for Off-grid Projects through IREDA : MNRE also provides subsidized debt subsidy equivalent to 60 percent of the total project cost for biomass-based RE projects. More details at a five percent interest rate for off-grid solar applications through IREDA. Most of these of subsidies are provided in Annex B. projects are developed by local developers, who approach local banks for debt financing. However, the subsidized debt is only available through IREDA and is not accessible to local 2.5.2 Rural Electrification Programs banks.

MNRE also provides subsidies to encourage rural electrification based on RE resources. However, 2.5.3 Commercial Off-grid Projects most of these subsidies are restricted to state implementation agencies and not-for-profit Biomass Projects organizations. The subsidies provided through these programs include:

MNRE provides capital subsidies for the industrial use of biomass for both combustion and • Decentralized Distributed Generation (DDG) scheme under Rajiv Gandhi Grameen Vidyutikaran gasification projects. For biomass combustion projects, the subsidy amount is the same as that Yojana, 2005 (RGGVY)37: The DDG scheme covers all un-electrified villages and hamlets with provided to grid-connected projects. little or no electricity access. The scheme promotes a Build Operate Maintain and Transfer (BOMT) model. Under this scheme, the government provides a capital subsidy of 90 percent For biomass gasification projects, MNRE provides subsidies for capacities up to 5 MW for both and pays eight percent of the total project cost as a service charge to the implementing electrical and thermal applications. These subsidies are up to INR 1 million per 100 kW (USD 16,000 agencies. Projects can only be implemented by government enterprises under this program. per 100 kW) for dual gas systems and INR 1.5 million per 100 kW (USD 24,000 per 100 kW) for 100 • Remote Village Electrification (RVE) Program38: This is MNRE's flagship scheme and was percent producer gas systems. An additional subsidy of 20 percent of the capital cost is available for started almost a decade ago (FY 2002-03). This scheme covers villages that are not covered special category states. under the RGGVY program and have been designated as being remote by GOI. The RVE Box 5: Limitations of Subsidy Schemes program also uses the BOMT model. The program provides a 90 percent capital subsidy, while the remaining 10 percent is funded by the state government or consumer contributions. The effectiveness of the existing subsidy programs is limited by the following reasons: Projects can only be implemented by government enterprises under this program. • Subsidies only guarantee capacity addition, while most financers would rather have an instrument that stimulates generation, as debt payback is dependent on generation. • Jawaharlal Nehru National Solar Mission (JNNSM): One of the key components of the JNNSM • Most subsidies are available only after successful commissioning of the project, thus forcing is the development of small and off-grid solar PV applications which include DDG based power the developer to raise full finance for the project's construction. plants. Under this program, MNRE supports village electrification projects that use solar • The application processing time taken by the MNRE and other state bodies for subsidies is energy with capacities up to 250 kWp through capital subsidies.39 The support also includes generally long (up to six months). Furthermore, the time required for disbursement of the soft loans from micro finance institutions (MFIs)/Banks which can be refinanced by Indian subsidy ranges from six months to one year. The cumbersome and long process for subsidy Renewable Energy Development Agency (IREDA) and/or National Bank for Agriculture and approval reduces the attractiveness of these incentives. Rural Development (NABARD) at a two percent interest rate. The remaining 20 percent of the Solar Projects investment must be arranged by the project manager or the RESCOs themselves. This scheme is available for private developers. Under JNNSM, MNRE provides capital subsidies for solar plants used for captive consumption (up to a capacity of 100 kWp). Up to 30 percent of the capital cost is provided as subsidy, with a cap of 37 Available at INR 30 per Wp (USD 0.48 per Wp) for projects without batteries and INR 63 per Wp (USD 1 per Wp) http://www.powermin.nic.in/whats_new/pdf/Guidelines_for_Village_Electrification_DDG_under_RGGVY.pdf, last accessed on September 13, 2013 for projects with batteries. 38 Available at http://www.mnre.gov.in/file-manager/offgrid-remote-village-programme/rve-adm-2011-12.pdf, last accessed on September 13. 2013. Subsidies available for off-grid renewable energy projects are provided in Annexes C to F. (See Box 5: 39 Subsidy is capped at INR 90 per Wp (USD 1.4 per Wp). Available at http://mnre.gov.in/file- Limitations of Subsidy Schemes) manager/UserFiles/amendmends-benchmarkcost-aa-jnnsm-2013-14.pdf, last accessed on September 13, 2013. 40 Available at http://mnre.gov.in/file-manager/UserFiles/FAQ_offgrid_solar.pdf, last accessed on September 13, 2013

16 PACE-D Technical Assistance Program Financing Renewable Energy in India 17 40 per MW (USD 32,000 per MW) in the rest of India. Some states, such as Bihar, also provide a capital • Interest Subsidy for Off-grid Projects through IREDA : MNRE also provides subsidized debt subsidy equivalent to 60 percent of the total project cost for biomass-based RE projects. More details at a five percent interest rate for off-grid solar applications through IREDA. Most of these of subsidies are provided in Annex B. projects are developed by local developers, who approach local banks for debt financing. However, the subsidized debt is only available through IREDA and is not accessible to local 2.5.2 Rural Electrification Programs banks.

16 PACE-D Technical Assistance Program Financing Renewable Energy in India 17 2.6 GENERATION BASED INCENTIVES

2.6.1 Wind Projects

41 Business Models for RE In December 2009, MNRE introduced the GBI scheme for wind energy projects to facilitate the 3 entry of large IPPs. This scheme was available only to those developers who did not avail themselves of accelerated depreciation benefits and sold power to the state distribution companies. Projects In India

Under the GBI scheme, IREDA provided an incentive of INR 0.50 per kWh (US cent 0.8 per kWh) of wind power fed into the grid, with a total project lifecycle cap of INR 6.25 million per MW (USD 0.1 3.1 GRID-CONNECTED RE million per MW) and an annual cap of INR 1.55 million per MW (USD 24,700 per MW). While the target was to develop 4,000 MW through GBI, the scheme was discontinued in March, 2012, even The business models for grid-connected RE projects are based mainly on three variables – power though only 2,247 MW of wind capacity had been installed under the scheme. However, it was sales (or power off-take arrangements), resources (the type of resource used and their availability), re-introduced in August 2013 and will be applicable for the entire period of the 12th Five Year Plan.42 and technology (type and maturity of technology used). These three variables define returns, key The cap on GBI was increased for a project to INR 10 million per MW (USD 0.16 million per MW) risks, and the overall bankability of a project (See Table 1: Business Models for Grid-Connected RE with an annual cap of INR 2.5 million per MW (USD 40,000 per MW). Projects). They are further explained below:

2.6.2 Solar Projects • Power Off-take Arrangements: The revenue model for the project is defined by the power GBIs are provided to state utilities for the solar projects developed under the JNNSM's Rooftop PV off-take arrangement and depends largely on central and state government policies and and Small Solar Power Generation Program (RPSSGP).43 About 100 MW of solar capacity was regulations such as open access, FiTs and RPOs; industrial and commercial tariffs in the allotted under this scheme in 2010, of which 98 MW has been developed across 78 projects. Under states; and the creditworthiness of off-takers such as DISCOMs and open access RPSSGP, state utilities purchased electricity from generators at the benchmark tariff of INR 17.91 per consumers. kWh (USD 0.29 per kWh). Of this amount IREDA refunded them all but a reference tariff of INR 5.5 per kWh (US cents 8.8 per kWh), which increases at three percent annually. • Resource: A key driver of the cost of generation for RE projects is the availability of 2.7 INCLUDING OFF-GRID RE PROJECTS IN PRIORITY SECTOR LENDING resources, which has a significant impact on the costs, risks, energy generation, profitability and bankability of the project. For example, biomass-based projects face significant In its revised guidelines, the Reserve Bank of India (RBI) has recently included loans made to off-grid feedstock supply risks; their costs and capacity utilization are also highly dependent on the 44 RE applications as part of priority sector lending for banks. This new classification provides benefits type of biomass used. to off-grid RE projects, as outlined below:

• The RBI mandates banks to have 40 percent of their exposure to priority sectors (as defined by the RBI), but banks often find it difficult to achieve this target. Thus, the recent inclusion of off-grid RE projects to this target will enable such projects to receive more attention from banks. • Loans covered under banks' priority sector targets are provided at concessional rates, which are one to two percent lower than normal commercial lending rates.

41 Available at http://pib.nic.in/newsite/erelease.aspx?relid=56147, last accessed on September 13, 2013. 42 Available at http://www.pib.nic.in/newsite/erelease.aspx?relid=78829, last accessed on September 13, 2013. 43 Available at http://www.pib.nic.in/newsite/erelease.aspx?relid=78829, last accessed on September 13, 2013. 44 Available at http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=7460&Mode=0, last accessed on September 2013.

18 PACE-D Technical Assistance Program Financing Renewable Energy in India 19 2.6 GENERATION BASED INCENTIVES

2.6.1 Wind Projects

18 PACE-D Technical Assistance Program Financing Renewable Energy in India 19 • Technology: The predictability of electricity generation by a technology is a key risk for RE projects. Predictability depends upon the maturity of the technology and the project design, implementation and operation of its application. New and emerging technologies usually Table 1: IPP Business Models for Grid-Connected Renewable Energy Projects45 carry a higher risk relative to older technologies that are more mature and have considerable market experience in their design, implementation and operation. Thus new technologies Parameters Solar Wind Small hydro Biomass often fail to garner interest from developers and financers. Power Off- (i) Sale to Distribution (i) Sale to Distribution Companies at take (Revenue Companies / other (a) FiT The business models that have been used in India for renewable generation include: Model) designated (b) APPC with RECs entities such as • Captive Model – An industry or the energy user invests in, develops and operates a RE NTPC Vidyut (ii) Sale to captive / open access consumers with RECs. project to meet its own electricity needs. Investment is mostly driven by the need to gain Vyapar Nigam at FiT access to power, depreciation tax benefits and subsidies. Debt for these projects is provided (ii) Sale to by the user's existing lenders, often with recourse to the user's balance sheet. Lenders Distribution consider these projects to be relatively less risky. Companies at APPC with RECs • Managed Asset Model – Under this model, investors finance the project to benefit from tax (iii) Sale to captive / savings such as accelerated depreciation. RE assets developed under this model are open access managed by third parties, mostly the original equipment manufacturers (OEMs). This model consumers with was very popular for wind project development and was the primary reason for the growth RECs (less common) of wind sector in the early 2000s. Investments in wind projects declined after the withdrawal of depreciation benefits. Investments in solar projects are starting to increase Resource Accurate resource Assessment Assessment Assessment under this model. Lender financing is mostly based on the creditworthiness of the project (Cost of estimation has a methodologies for methodologies for methodologies well developer, the asset manager or the OEM who will manage the asset. Lenders are now generation and significant impact on wind resource mapping hydrological established; increasingly realizing that there is a higher risk of an asset's non-performance when the profitability) the profitability of a assessment are well resources are well however, alternate solar project. Accurate established and established. resource usage/ manager of the asset is an OEM, because the OEM has no financial interest in ensuring the ground level radiation accepted. collection poses a assessment is Development risks sustenance and efficient operation of the project after the equipment has been sold. However, scale up challenge. Woody available only for a along with long and access to appropriate biomass, rice husk, maximum of two year complex permitting • Independent Power Producers – The investors in such models are large strategic or financial sites remains an cotton and maize period. In absence of issue. process remain investors who invest, own and operate the assets efficiently to maximize cash flows. This this data, developers critical issues. stocks used as model is gaining prominence in India and will require scale up in non-recourse finance. use satellite data for fuels. making projections for Need third party IPPs focus on resource availability, site selection, mode of electricity sale, technology generation from collection and bio- selection, EPC contractor's selection, mode of financing, and management of benefits (e.g. projects. There can mass processing be errors in such companies who RECs, carbon credits, subsidies, etc.). The advent of IPPs has also resulted in the estimation, which have the ability to may be unacceptably introduction of many new means of financing including capital markets, supplier financing assure quality and high for CSPs. More (e.g. Export-Import financing), and external commercial borrowings (ECBs). IPPs are critical quantity of bio- accurate for the future scale up of RE investments. measurements are mass. needed. The basic characteristics of the IPP model as applied to the different types of RE are outlined in Table 1. 45 Based on Research undertaken by Emergent Ventures India

20 PACE-D Technical Assistance Program Financing Renewable Energy in India 21 • Technology: The predictability of electricity generation by a technology is a key risk for RE projects. Predictability depends upon the maturity of the technology and the project design, implementation and operation of its application. New and emerging technologies usually Table 1: IPP Business Models for Grid-Connected Renewable Energy Projects45 carry a higher risk relative to older technologies that are more mature and have considerable market experience in their design, implementation and operation. Thus new technologies Parameters Solar Wind Small hydro Biomass often fail to garner interest from developers and financers. Power Off- (i) Sale to Distribution (i) Sale to Distribution Companies at take (Revenue Companies / other (a) FiT The business models that have been used in India for renewable generation include: Model) designated (b) APPC with RECs entities such as • Captive Model – An industry or the energy user invests in, develops and operates a RE NTPC Vidyut (ii) Sale to captive / open access consumers with RECs. project to meet its own electricity needs. Investment is mostly driven by the need to gain Vyapar Nigam at FiT access to power, depreciation tax benefits and subsidies. Debt for these projects is provided (ii) Sale to by the user's existing lenders, often with recourse to the user's balance sheet. Lenders Distribution consider these projects to be relatively less risky. Companies at APPC with RECs • Managed Asset Model – Under this model, investors finance the project to benefit from tax (iii) Sale to captive / savings such as accelerated depreciation. RE assets developed under this model are open access managed by third parties, mostly the original equipment manufacturers (OEMs). This model consumers with was very popular for wind project development and was the primary reason for the growth RECs (less common) of wind sector in the early 2000s. Investments in wind projects declined after the withdrawal of depreciation benefits. Investments in solar projects are starting to increase Resource Accurate resource Assessment Assessment Assessment under this model. Lender financing is mostly based on the creditworthiness of the project (Cost of estimation has a methodologies for methodologies for methodologies well developer, the asset manager or the OEM who will manage the asset. Lenders are now generation and significant impact on wind resource mapping hydrological established; increasingly realizing that there is a higher risk of an asset's non-performance when the profitability) the profitability of a assessment are well resources are well however, alternate solar project. Accurate established and established. resource usage/ manager of the asset is an OEM, because the OEM has no financial interest in ensuring the ground level radiation accepted. collection poses a assessment is Development risks sustenance and efficient operation of the project after the equipment has been sold. However, scale up challenge. Woody available only for a along with long and access to appropriate biomass, rice husk, maximum of two year complex permitting • Independent Power Producers – The investors in such models are large strategic or financial sites remains an cotton and maize period. In absence of issue. process remain investors who invest, own and operate the assets efficiently to maximize cash flows. This this data, developers critical issues. stocks used as model is gaining prominence in India and will require scale up in non-recourse finance. use satellite data for fuels. making projections for Need third party IPPs focus on resource availability, site selection, mode of electricity sale, technology generation from collection and bio- selection, EPC contractor's selection, mode of financing, and management of benefits (e.g. projects. There can mass processing be errors in such companies who RECs, carbon credits, subsidies, etc.). The advent of IPPs has also resulted in the estimation, which have the ability to may be unacceptably introduction of many new means of financing including capital markets, supplier financing assure quality and high for CSPs. More (e.g. Export-Import financing), and external commercial borrowings (ECBs). IPPs are critical quantity of bio- accurate for the future scale up of RE investments. measurements are mass. needed. The basic characteristics of the IPP model as applied to the different types of RE are outlined in Table 1. 45 Based on Research undertaken by Emergent Ventures India

20 PACE-D Technical Assistance Program Financing Renewable Energy in India 21 3.2 RURAL ELECTRIFICATION PROJECTS Parameters Solar Wind Small hydro Biomass The business models used for rural electrification projects are similar to those used for grid Technology Solar PV is a well- Technologies are well Technologies are well Biomass 46 (Generation established established. established. combustion and connected projects except for the power off-take arrangements. For grid-connected projects, the Risk) technology gasification power off-takers are DISCOMs and bulk consumers while for rural electrification projects, the off- worldwide. However technologies are takers are retail consumers in rural areas. Off-taker risk is higher in rural electrification projects due risks exist in terms well established to the low paying capacity of many energy users in rural areas. The size of rural electrification of technology for certain fuel performance, types. However projects is usually small, in the order of a few kWs and as a result, solar PV and biomass gasification business continuity multi-fuel are preferred technologies due to their commercial feasibility at small capacities.47 Moreover these of vendors, capabilities, quality two technologies are modular and hence easier to scale up. performance of EPC of equipment and contractors, etc. design for bio- Many micro-grid operators have emerged, playing the role of both generators as well as distributors CSP is a developing mass processing technology, not well remain critical of electricity. These operators find raising debt finance challenging due to the small ticket size and established in India. issues. the perception that rural consumers have poor creditworthiness. Risks of resource assessment and 3.3 COMMERCIAL AND INDUSTRIAL OFF-GRID RE PROJECTS technology performance remain. Off-grid C&I applications of RE include all on-site captive energy needs. These include: • Electrical and thermal energy (heating, cooling, and steam); Equity A number of private equity investors are active in Sources of investments are limited to • Applications where diesel generators, captive gas, or coal based power plants currently Sources the market. The investors have not been able to specialized funds of strategic investors. supply power (supplemented by the grid), which can be replaced, partly or fully, by make exits through capital markets, due to market conditions, low profitability, and lack of Very few players are interested due to the on-site RE; scale. high risks of the sector and low scalability. • Captive RE to offset grid power.

Debt Finance Debt financing is available from Indian FIs with FIs consider these projects to have high The type of users covered in C&I off-grid applications are: tenure of 8 to 12 years with recourse at an risks. So lending to these projects has been • Large aggregated users such as residential complexes, shopping malls, and industries within interest rate of 12 to 15 percent. low. However, debt financing for fully a special economic zone; developed projects is relatively easier. Debt financing for longer tenure with no • Utility service providers such as municipal corporations (e.g. street lights, and water and recourse and a lower interest rate is needed to waste management); scale up investments. • Service providers such as railways, airports, petrol pumps, hotels, hospitals, schools, universities, government offices, entertainment centres, and exhibition halls; • Industries requiring on-site power generation to face shortages in grid power and the need to shift to RE due to RPO. The RESCO model is gaining popularity for development of off-grid systems for C&I users. Under this model, a RESCO develops an off-grid system within the consumer's premises and sells the energy generated to the consumer.

46 Government developed projects and their business models are not included 47 CSP, Wind, Small Hydro and Biomass Combustion technologies are not commercially feasible in smaller capacities. Moreover these technologies need detailed resource assessment.

22 PACE-D Technical Assistance Program Financing Renewable Energy in India 23 3.2 RURAL ELECTRIFICATION PROJECTS Parameters Solar Wind Small hydro Biomass The business models used for rural electrification projects are similar to those used for grid Technology Solar PV is a well- Technologies are well Technologies are well Biomass 46 (Generation established established. established. combustion and connected projects except for the power off-take arrangements. For grid-connected projects, the Risk) technology gasification power off-takers are DISCOMs and bulk consumers while for rural electrification projects, the off- worldwide. However technologies are takers are retail consumers in rural areas. Off-taker risk is higher in rural electrification projects due risks exist in terms well established to the low paying capacity of many energy users in rural areas. The size of rural electrification of technology for certain fuel performance, types. However projects is usually small, in the order of a few kWs and as a result, solar PV and biomass gasification business continuity multi-fuel are preferred technologies due to their commercial feasibility at small capacities.47 Moreover these of vendors, capabilities, quality two technologies are modular and hence easier to scale up. performance of EPC of equipment and contractors, etc. design for bio- Many micro-grid operators have emerged, playing the role of both generators as well as distributors CSP is a developing mass processing technology, not well remain critical of electricity. These operators find raising debt finance challenging due to the small ticket size and established in India. issues. the perception that rural consumers have poor creditworthiness. Risks of resource assessment and 3.3 COMMERCIAL AND INDUSTRIAL OFF-GRID RE PROJECTS technology performance remain. Off-grid C&I applications of RE include all on-site captive energy needs. These include: • Electrical and thermal energy (heating, cooling, and steam); Equity A number of private equity investors are active in Sources of investments are limited to • Applications where diesel generators, captive gas, or coal based power plants currently Sources the market. The investors have not been able to specialized funds of strategic investors. supply power (supplemented by the grid), which can be replaced, partly or fully, by make exits through capital markets, due to market conditions, low profitability, and lack of Very few players are interested due to the on-site RE; scale. high risks of the sector and low scalability. • Captive RE to offset grid power.

22 PACE-D Technical Assistance Program Financing Renewable Energy in India 23 The business models for off-grid commercial applications are the same as those for off-grid rural projects except for power off-take arrangements. In this case, power off-takers are commercial Commercial Financing Instruments consumers. The risk of power off-take depends on the credit rating of the consumers. The sizes of 4 commercial off-grid projects vary from few kWs to several MWs. Solar PV and biomass gasification for RE in India are preferred technologies. However, the RESCO approach has not been successful for off-grid C&I projects due to significant effort need for identifying viable projects, persuading customers to invest 4.1 DEBT INSTRUMENTS in these projects (as customers consider these projects as non-core), and small ticket size of the transaction. Debt is an important means to reduce cost of capital as the cost of debt is lower than equity. In India, generally 70 percent of project costs are funded through conventional term loans. Domestic banks and Non-Banking Finance Companies (NBFCs)48 are the major sources of debt in India. International development banks fund RE in India but mostly through credit lines to banks and NBFCs. Several RE projects are funded by foreign currency loans which aim to promote specific technologies. This section identifies and describes some of the most common debt instruments used for RE financing in India.

4.1.1 Local Currency Loans

Debt financing for RE projects in India is predominantly provided through local currency term loans by FIs. Developers typically approach banks for debt financing during the development stage of the project after which PPAs are signed. A majority of these loans are with recourse to the borrower (i.e., the borrowers guarantee the loan repayments by providing a full or partial guarantee from their existing asset base). FIs also use other assets like property and fixed deposits as collateral if a sufficiently strong balance sheet is not available. (See Table 2: Prominent FIs Providing Rupee Term Loans to RE Projects)

48 NBFCs are financial institutions that provide banking services without meeting the legal definition of a bank, i.e. one that does not hold a banking license and, thus, is not allowed to accept deposits from the public.

24 PACE-D Technical Assistance Program Financing Renewable Energy in India 25 The business models for off-grid commercial applications are the same as those for off-grid rural projects except for power off-take arrangements. In this case, power off-takers are commercial Commercial Financing Instruments consumers. The risk of power off-take depends on the credit rating of the consumers. The sizes of 4 commercial off-grid projects vary from few kWs to several MWs. Solar PV and biomass gasification for RE in India are preferred technologies. However, the RESCO approach has not been successful for off-grid C&I projects due to significant effort need for identifying viable projects, persuading customers to invest 4.1 DEBT INSTRUMENTS in these projects (as customers consider these projects as non-core), and small ticket size of the transaction. Debt is an important means to reduce cost of capital as the cost of debt is lower than equity. In India, generally 70 percent of project costs are funded through conventional term loans. Domestic banks and Non-Banking Finance Companies (NBFCs)48 are the major sources of debt in India. International development banks fund RE in India but mostly through credit lines to banks and NBFCs. Several RE projects are funded by foreign currency loans which aim to promote specific technologies. This section identifies and describes some of the most common debt instruments used for RE financing in India.

4.1.1 Local Currency Loans

24 PACE-D Technical Assistance Program Financing Renewable Energy in India 25 Table 2: Prominent FIs Providing Rupee Term Loans to RE Projects Commercial Banks

Government Backed NBFCs Public sector banks Private sector banks Private NBFCs Infrastructure financing for private sector projects in India has been led by commercial banks. Commercial banks have also been at the forefront of lending to the power sector with a Indian Renewable Energy State Bank of India ICICI Bank L&T Infrastructure 50 Development Agency (IREDA) Finance compounded annual growth of 41 percent over a five year period from FY 2008-09 to FY 2012-13.

Power Finance Corporation Canara Bank Axis Bank Tata Capital Public Sector Banks Power Trading Corporation Central Bank of India HDFC Bank 51 Rural Electrification Corporation Punjab National Bank IDFC Bank While public sector banks dominate commercial lending in India, their presence in the power India Infrastructure Finance Andhra Bank Standard Chartered Bank sector, under which lending to RE projects classified, is limited. The exposure of public sector banks Company Ltd. to the power sector varies from bank to bank, based on sector limits defined by each bank. For instance, Canara Bank has 13 percent of its loan portfolio exposed to the power sector, while for the Government-backed NBFCs exposure for Bank of Baroda is only 2.6 percent.52 However, most public sector banks have now started scaling back their exposure to the power sector due to deteriorating financial health of the IREDA and Power Finance Corporation (PFC), two GOI-backed NBFCs, lead debt financing of RE state owned utilities. Banks are now using stricter norms for lending to the sector, especially to projects in India. As of March, 2012, IREDA and PFC have financed over 4 GW, which represents projects entering into financial contracts with state owned utilities. This has impacted the availability roughly 15 percent of the total 29.8 GW RE capacity installed in the country (See Box 6: IREDA and of debt to RE project developers as they usually enter into PPAs with these utilities. (See Box 7: PFC). Public Sector Bank Lending for First Time RE Developers.)

The interest rates for loans provided to RE projects by IREDA and PFC range between 12 and 14 Box 7: Public Sector Bank Lending for First Time RE Developers percent, with tenure around 10 years. Most loans provided by these institutions have a partial or full Most RE projects being funded by public sector banks are based on existing relationships that the recourse to the parent entity. banks have with project promoters. These banks do not have a loan portfolio that exclusively deals with RE projects. First time developers without existing banking relationships find it very difficult to Box 6: IREDA and PFC get a project financed from public sector bank. Moreover, public sector banks are more stringent in project evaluation and thus end up lending to fewer RE projects. Interest rates on loans for RE IREDA is a public limited government company established in 1987, under the administrative control projects range between 12 and 14 percent with tenures ranging from 8 to 12 years. Loans are of MNRE, to promote, develop and extend financial assistance for the development of RE and EE. provided to fund 60 to 70 percent of the project cost. IREDA has played a critical role in catalyzing RE deployment in India and has funded (as of March 31, 2012) a cumulative commissioned capacity of over 3 GW (IREDA, 2012). Private Sector Banks IREDA is also the preferred vehicle for international development banks for channeling funds to RE in India. It has received substantial funding - nearly INR 36.9 billion (USD 589 million) from Indian private sector banks, such as ICICI Bank and HDFC Bank, are relatively less active in the development banks, such as KfW, ADB, World Bank, AFD, and JICA in the form of low cost credit power sector. The loan portfolios of these banks have an exposure of about one percent to the lines guaranteed by the GOI. IREDA also sources funds from the domestic financial market and has raised INR 9.9 billion (USD 157 million) through domestic bond placements (both taxable and tax power sector, as compared to public sector banks whose average exposure is about seven percent. free) and INR 4.2 billion (USD 67 million) loans through domestic commercial banks.49 Private sector banks lend to RE projects mostly on the basis of their relationship with promoters and guarantees provided by them. Interest rates on loans range between 13 and 15 percent with PFC, a GOI-sponsored NBFC dedicated to power sector financing, is also one of the leading FIs tenures between 5 and 10 years. financing RE projects in the country. As of March 2012, PFC has funded over 1 GW of RE through its subsidiary PFC Green Energy Ltd (PFC, 2012). 50 Available at http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=831, last accessed on September 13, 2013 51 Public Sector Banks are banks where at least 50 percent of the shares are held by the government 49 Available at http://www.ireda.gov.in/forms/contentpage.aspx?lid=741, last accessed on September 13, 2013 52 Available at http://www.firstpost.com/investing/which-banks-need-to-worry-the-most-if-the-power-sector- defaults-119455.html, Last accessed on September 13, 2013

26 PACE-D Technical Assistance Program Financing Renewable Energy in India 27 Table 2: Prominent FIs Providing Rupee Term Loans to RE Projects Commercial Banks

26 PACE-D Technical Assistance Program Financing Renewable Energy in India 27 4.1.2 Foreign Currency Loans Private NBFCs Foreign currency loans are provided to RE projects by development banks, export-import (EXIM) Private NBFCs such as L&T Infrastructure Finance and Tata Capital are more receptive to financing banks, and international banks. These loans carry low interest rates ranging between three and six percent, with tenures between 10 and 18 years. However, all foreign currency loans carry an RE projects and have been active in the solar and wind energy space. These NBFCs process loans exchange rate fluctuation risk. Annex H highlights some of the foreign currency loans for RE projects faster (in one to two months, as compared to three to four months by public sector banks), and in India. (See Box 9: Limitations of Debt Financing with Foreign Currency Loans in India) charge higher interest rates (ranging between 13 and 15 percent) but provide longer tenures (between 10 and 15 years). Most private NBFCs provide loans on a non-recourse or limited recourse External Commercial Borrowing Regulations basis without substantial guarantees from the parent company, with lien on the assets being financed. A number of debt instruments used to raise funds from international markets are called ECB. The RBI monitors and regulates the flow of ECBs into India.53 Although local debt financing provides a majority of the lending to RE, the sector still suffers from a number of limitations which further constrain the flow of funds. (See Box 8 : Limitations of Debt Limits on Amount of ECB and Interest Rate Financing with Local Currency Loans). RBI regulations allow up to USD 750 million per ECB transaction with a minimum maturity of five years under the automatic route (wherein no separate RBI approval is required). Higher amounts Box 8 : Limitations of Debt Financing with Local Currency Loans require prior approval by the RBI. The RBI also permits supplier's and buyer's credits with tenure lower than three years, up to USD 20 million per transaction under the automatic route. Also a 1. The high interest rates (interest rates between 12 and15 percent) in India have led to an increase ceiling on the interest rates for ECBs has been set to 300 basis points above London Inter-bank in the cost of debt for RE projects. Offered Rate (LIBOR)54 for the automatic approval route for tenures between three to five years and 2. Long tenure debt of over 10 to 15 years is usually unavailable for Rupee term loans, thus 500 basis points above LIBOR for the automatic and approval routes for tenures above five years. stressing the cash flows from the projects in the initial years and impacting their financial attractiveness. End-use Restrictions 3. Fixed interest rate debt for rupee term loans is quite rare, with most FIs providing floating interest rates. This reduces the predictability of cash flows and exposes the projects to interest The RBI prohibits companies from using funds raised through ECBs for the following purposes: rate fluctuations. • On-lending, investment in capital markets, acquisition of companies, or part thereof: 4. Debt funding of RE projects by FIs in India needs to be guaranteed partially or fully by the parent Developers cannot raise funds through their parent company and lend it to a SPV. Each SPV entity; only a few private FIs provide debt to projects without a guarantee from the parent entity. needs to have separate ECB funding. 5. Banks internally define sector limits and RE is covered under the power sector limits. As most • Purchase of land. banks are approaching their power sector limits, they are often not able to provide financing to • Working capital: Developers cannot fund working capital from ECB. Biomass projects have a RE projects. considerable working capital requirement, which cannot be met through ECB. 6. Some banks do not lend to RE projects due to unfamiliarity with RETs, markets and related government policies. Project Finance from Development Banks 7. State level policies, along with the poor financial condition of state utilities, restrict lending to Development finance institutions, such as the International Finance Corporation (IFC), Deutsche only a few states. Investitions-und Entwicklungsgesellschaft (DEG), and Asian Development Bank (ADB) have been funding RE projects in India through foreign currency loans either in U.S. Dollars or Euros. The interest rate for such loans ranges between four and six percent, with tenures between 10 to 15 A sample list of RE projects which have been financed through local currency loans has been years with limited or no recourse. provided in Annex H. 53 Available at http://rbidocs.rbi.org.in/rdocs/notification/PDFs/12MCECB290613.pdf, last accessed on Septmeber 13, 2013 54 6 month LIBOR

28 PACE-D Technical Assistance Program Financing Renewable Energy in India 29 4.1.2 Foreign Currency Loans Private NBFCs Foreign currency loans are provided to RE projects by development banks, export-import (EXIM) Private NBFCs such as L&T Infrastructure Finance and Tata Capital are more receptive to financing banks, and international banks. These loans carry low interest rates ranging between three and six percent, with tenures between 10 and 18 years. However, all foreign currency loans carry an RE projects and have been active in the solar and wind energy space. These NBFCs process loans exchange rate fluctuation risk. Annex H highlights some of the foreign currency loans for RE projects faster (in one to two months, as compared to three to four months by public sector banks), and in India. (See Box 9: Limitations of Debt Financing with Foreign Currency Loans in India) charge higher interest rates (ranging between 13 and 15 percent) but provide longer tenures (between 10 and 15 years). Most private NBFCs provide loans on a non-recourse or limited recourse External Commercial Borrowing Regulations basis without substantial guarantees from the parent company, with lien on the assets being financed. A number of debt instruments used to raise funds from international markets are called ECB. The RBI monitors and regulates the flow of ECBs into India.53 Although local debt financing provides a majority of the lending to RE, the sector still suffers from a number of limitations which further constrain the flow of funds. (See Box 8 : Limitations of Debt Limits on Amount of ECB and Interest Rate Financing with Local Currency Loans). RBI regulations allow up to USD 750 million per ECB transaction with a minimum maturity of five years under the automatic route (wherein no separate RBI approval is required). Higher amounts Box 8 : Limitations of Debt Financing with Local Currency Loans require prior approval by the RBI. The RBI also permits supplier's and buyer's credits with tenure lower than three years, up to USD 20 million per transaction under the automatic route. Also a 1. The high interest rates (interest rates between 12 and15 percent) in India have led to an increase ceiling on the interest rates for ECBs has been set to 300 basis points above London Inter-bank in the cost of debt for RE projects. Offered Rate (LIBOR)54 for the automatic approval route for tenures between three to five years and 2. Long tenure debt of over 10 to 15 years is usually unavailable for Rupee term loans, thus 500 basis points above LIBOR for the automatic and approval routes for tenures above five years. stressing the cash flows from the projects in the initial years and impacting their financial attractiveness. End-use Restrictions 3. Fixed interest rate debt for rupee term loans is quite rare, with most FIs providing floating interest rates. This reduces the predictability of cash flows and exposes the projects to interest The RBI prohibits companies from using funds raised through ECBs for the following purposes: rate fluctuations. • On-lending, investment in capital markets, acquisition of companies, or part thereof: 4. Debt funding of RE projects by FIs in India needs to be guaranteed partially or fully by the parent Developers cannot raise funds through their parent company and lend it to a SPV. Each SPV entity; only a few private FIs provide debt to projects without a guarantee from the parent entity. needs to have separate ECB funding. 5. Banks internally define sector limits and RE is covered under the power sector limits. As most • Purchase of land. banks are approaching their power sector limits, they are often not able to provide financing to • Working capital: Developers cannot fund working capital from ECB. Biomass projects have a RE projects. considerable working capital requirement, which cannot be met through ECB. 6. Some banks do not lend to RE projects due to unfamiliarity with RETs, markets and related government policies. Project Finance from Development Banks 7. State level policies, along with the poor financial condition of state utilities, restrict lending to Development finance institutions, such as the International Finance Corporation (IFC), Deutsche only a few states. Investitions-und Entwicklungsgesellschaft (DEG), and Asian Development Bank (ADB) have been funding RE projects in India through foreign currency loans either in U.S. Dollars or Euros. The interest rate for such loans ranges between four and six percent, with tenures between 10 to 15 A sample list of RE projects which have been financed through local currency loans has been years with limited or no recourse. provided in Annex H. 53 Available at http://rbidocs.rbi.org.in/rdocs/notification/PDFs/12MCECB290613.pdf, last accessed on Septmeber 13, 2013 54 6 month LIBOR

28 PACE-D Technical Assistance Program Financing Renewable Energy in India 29 EXIM Finance Box 9: Limitations of Debt Financing with Foreign Currency Loans in India

For foreign currency loans, the interest and debt repayment have to be made in foreign currency, EXIM Banks are credit agencies set up by governments to support export of locally manufactured whereas the revenue from RE projects in India is generated in Indian Rupees. The required foreign goods to international markets through working capital finance (pre-export financing), post shipment currency payments carry a risk of exchange rate fluctuations. Further, some lenders mandate partial credits (short term), long term supplier finance, export credit insurance, loan guarantees, and direct or full hedging of the debt component. Hedging costs add another three to six percent to the cost of loans (buyer financing). The EXIM Banks of U.S. and China, and the Japan Bank for International the loan. Debt from international commercial banks is more expensive (as compared to EXIM), as it Cooperation (JBIC) are a few examples. is adjusted for country risk. Even with the sovereign risk and hedging costs, foreign currency loans may cost about two percent lower than domestic loans. However, their major attractiveness lies in For long term financing, EXIM banks provide loan guarantees and direct loans to the developers. longer tenures. The challenge is in being able to get long-term hedges for the currency risk. These loans and guarantees can be based either on the entire project cost or just restricted to the cost of the imports and associated local costs from the EXIM bank's country. The interest rate for RBI has set interest rate ceilings for ECBs. This limits the lenders' flexibility to price-in applicable risk EXIM long-term finance ranges between three and five percent (without currency hedge) with in interest rates. Some lenders may be unwilling to provide finance to Indian RE projects because of tenures above 15 years. these restrictions.

EXIM Bank of the U.S. 4.1.3 Supplier Credit Since 2007, the EXIM Bank of the U.S. (U.S. EXIM) has provided funding of USD 1.5 billion for RET Some suppliers extend credit to RE projects, limited to the value of the material supplied by them. exports from the U.S. to global markets (U.S. EXIM, 2012). U.S. EXIM funds up to 85 percent of the These can be local currency or foreign currency denominated, and may or may not carry interest, total value of technology exported from U.S. for a tenure of up to 18 years with limited or no recourse. Interest rates are based on the project risk and the minimum interest rate, which is the depending on the negotiation between the borrower and the supplier. Supplier credit is extended for average of the U.S. Treasury rates for the preceding month plus one percent (for example the a period of one to three years, normally the construction period. On commissioning the project, minimum interest rate for the month July 15, 2013 to August 14, 2013 for an 18 year loan was 3.5 developers substitute the supplier credit with a term loan. Suppliers normally require a letter of percent55). The interest rates on U.S. EXIM loans to Indian RE projects range between four to six credit from the project owner for the value and term of the credit. percent. The bank has funded a number of solar projects in India developed by IPPs, such as Reliance Power, Azure Power, and Kiran Energy. 4.1.4 Construction Finance/Bridge Finance

Other EXIM Banks The construction phase of a project is associated with the highest risk in the entire lifecycle of the project. Therefore, term loans raised during pre-construction phase entail higher interest rates Other major exporting countries, like Japan and China, also provide loans for RE projects on reflecting the higher risks. Term loans raised post commissioning are raised on a lower risk profile. favorable terms. JBIC has formed a USD 200 million fund with ICICI Bank to provide loans to clean Project developers use short term loans to fund projects during the construction period, and then energy projects in India.56 refinance the loans with cheaper term loans post commissioning. These loans are provided by private NBFCs and commercial banks in India. In some cases, construction loans convert into term loans once the project achieves commercial operations.

4.1.5 Take-out Finance/Refinance

Take-out finance or refinance57 is a common method of financing operating assets. The majority of FIs provide take-out financing for infrastructure projects. When the project commences operations 55 Available at http://www.exim.gov/tools/commercialinterestreferencerates/index.cfm, last accessed on September 2013 57 56 Available at http://www.icicibank.com/aboutus/pdf/ICICI-JBIC-Aug07.pdf, last accessed on September 2013 Take-out Finance or refinance means the replacement of existing sources of finance with newer ones, usually at better terms

30 PACE-D Technical Assistance Program Financing Renewable Energy in India 31 EXIM Finance Box 9: Limitations of Debt Financing with Foreign Currency Loans in India

4.1.5 Take-out Finance/Refinance

30 PACE-D Technical Assistance Program Financing Renewable Energy in India 31 4.1.6 Lease Financing and cash flows become stable, the operational risk is reduced considerably. Hence, developers refinance these loans to get better terms, such as higher debt-equity ratio, lower interest rate, and In the past, FIs and IPPs, especially those focused on wind energy, worked together to use lease longer loan tenure. With refinancing, part of the cash invested by the developer can also be released financing to benefit from accelerated depreciation. Lease financing is a commercial arrangement making it possible to develop more borrowing capacity. between an FI and the project developer, where the former purchases the generating equipment and other components (usually equivalent to 70 to 80 percent of the project cost) and leases them Take-out Finance through ECBs to the latter (See Figure 2: Structure of Lease Financing in India). Project developers traditionally hold power projects in SPVs and are thus unable to claim accelerated depreciation on such projects. A RBI allows infrastructure projects, including RE projects, to refinance rupee debt using ECBs, but capital lease allows the project to benefit from accelerated depreciation and is mutually beneficial to with prior RBI approval. Eligibility criteria for ECB refinancing include: (I) Take-out finance must be both the FI and the project developer while working as a proxy for debt in the capital structure of the within the first three years of commercial operation; (ii) Loans provided through ECBs must have a project (See Table 3: Mutual Benefits of Lease Financing to FI and Project Developer). minimum maturity of seven years; and (iii) Other conditions on end user, loan amount, and interest are applicable. Table 3: Mutual Benefits of Lease Financing to FI and Project Developer However, take-out finance through ECBs has limitations. For instance, according to RBI guidelines, Benefits to FI Benefits to project developer such mechanisms require a tripartite agreement between the developer, the domestic bank, and the foreign bank. This can be challenging as both foreign and domestic banks are often uncomfortable Generates business by providing debt in the form of The project developer is able to get access to debt, with their counterpart's jurisdiction. lease to the project developer. but in the form of lease. Since the assets are purchased on the balance sheet of The terms a project developer gets under leasing Infrastructure Debt Fund the FI, it can claim accelerated depreciation benefits finance arrangement are usually better than those of applicable for RE projects under the IT Act, 1961. a term loan, as some benefits from the accelerated In 2011-12, the GOI allowed the setting up of IDFs to ease and accelerate the flow of funds into depreciation are passed on to the developer by the FI. infrastructure development projects. IDFs allow tapping long-term, low-cost debt from insurance and pension funds, and other long-term domestic and foreign investors. In India, the leasing industry is dominated by NBFCs. Though the banks are allowed to perform leasing activities, they do not have significant presence in this sector. NBFCs and commercial banks are the main source of debt in India. However, they typically face difficulties in providing long-term funding for infrastructure projects due to an asset-liability mismatch. In addition, banks have to deal with internally set sector limits. IDFs are allowed to Figure 2: Structure of Lease Financing in India refinance bank debt of operating infrastructure projects, thereby releasing capacity of banks to lend again. Developer

NBFCs have shown a substantial interest in IDFs but IDFs are yet to be used for refinancing RE 58 projects. Recently IIFCL has registered IDFs for road projects. IDFs have been discussed in detail Equity & under section 6. management Down payment for leasing equipment Financial Project Company (Equivalent to equity) Institution (SPV or IPP) Pays lease rent (Lender) (Equivalent to debt repayment)

58 Available at Buys and leases asset http://www.iifcl.org/WriteReadData/MediaRoom/Documents/201306211254189345703PressRelease_IDFLau nch_18062013.PDF, last accessed on September 13, 2013 Asset

Tax benefits due to accelerated depreciation

32 PACE-D Technical Assistance Program Financing Renewable Energy in India 33 4.1.6 Lease Financing and cash flows become stable, the operational risk is reduced considerably. Hence, developers refinance these loans to get better terms, such as higher debt-equity ratio, lower interest rate, and In the past, FIs and IPPs, especially those focused on wind energy, worked together to use lease longer loan tenure. With refinancing, part of the cash invested by the developer can also be released financing to benefit from accelerated depreciation. Lease financing is a commercial arrangement making it possible to develop more borrowing capacity. between an FI and the project developer, where the former purchases the generating equipment and other components (usually equivalent to 70 to 80 percent of the project cost) and leases them Take-out Finance through ECBs to the latter (See Figure 2: Structure of Lease Financing in India). Project developers traditionally hold power projects in SPVs and are thus unable to claim accelerated depreciation on such projects. A RBI allows infrastructure projects, including RE projects, to refinance rupee debt using ECBs, but capital lease allows the project to benefit from accelerated depreciation and is mutually beneficial to with prior RBI approval. Eligibility criteria for ECB refinancing include: (I) Take-out finance must be both the FI and the project developer while working as a proxy for debt in the capital structure of the within the first three years of commercial operation; (ii) Loans provided through ECBs must have a project (See Table 3: Mutual Benefits of Lease Financing to FI and Project Developer). minimum maturity of seven years; and (iii) Other conditions on end user, loan amount, and interest are applicable. Table 3: Mutual Benefits of Lease Financing to FI and Project Developer However, take-out finance through ECBs has limitations. For instance, according to RBI guidelines, Benefits to FI Benefits to project developer such mechanisms require a tripartite agreement between the developer, the domestic bank, and the foreign bank. This can be challenging as both foreign and domestic banks are often uncomfortable Generates business by providing debt in the form of The project developer is able to get access to debt, with their counterpart's jurisdiction. lease to the project developer. but in the form of lease. Since the assets are purchased on the balance sheet of The terms a project developer gets under leasing Infrastructure Debt Fund the FI, it can claim accelerated depreciation benefits finance arrangement are usually better than those of applicable for RE projects under the IT Act, 1961. a term loan, as some benefits from the accelerated In 2011-12, the GOI allowed the setting up of IDFs to ease and accelerate the flow of funds into depreciation are passed on to the developer by the FI. infrastructure development projects. IDFs allow tapping long-term, low-cost debt from insurance and pension funds, and other long-term domestic and foreign investors. In India, the leasing industry is dominated by NBFCs. Though the banks are allowed to perform leasing activities, they do not have significant presence in this sector. NBFCs and commercial banks are the main source of debt in India. However, they typically face difficulties in providing long-term funding for infrastructure projects due to an asset-liability mismatch. In addition, banks have to deal with internally set sector limits. IDFs are allowed to Figure 2: Structure of Lease Financing in India refinance bank debt of operating infrastructure projects, thereby releasing capacity of banks to lend again. Developer

58 Available at Buys and leases asset http://www.iifcl.org/WriteReadData/MediaRoom/Documents/201306211254189345703PressRelease_IDFLau nch_18062013.PDF, last accessed on September 13, 2013 Asset

Tax benefits due to accelerated depreciation

32 PACE-D Technical Assistance Program Financing Renewable Energy in India 33 4.2 EQUITY FINANCE Box 10: Earn-out based Equity Investment

Consider an example of an investor who has to invest USD 100 million in construction of a project Equity typically comprises 30 to 40 percent of the total project cost, while the rest is financed where pre- development activity has been carried out by the project promoter. Project pre- 59 through debt. Strategic investors, venture capital, private equity, tax equity investors , are the key development activities are valued at USD 50 million. This would make the value of the entire project 60 providers of equity to RE projects. In India, the hurdle rates for direct equity investments range USD 150 million, out of which promoter will ideally have a share of 33 percent (USD 50 million of between 16 and 20 percent, and are dependent on factors, such as the size of the project, the USD 150 million). Due to the significant implementation and performance risks associated with the background of sponsor, the technology risk, the stage of maturity, and geographic and policy risks. project, the investor may decide to provide an upfront value of only USD 10 million to the promoter instead of USD 50 million, with the balance value of USD 40 million as an “earn-out” linked to The key focus of developers and equity investors is on commercial scale RE projects especially large achievement of certain project milestones. In this case, the promoter's shareholding at the time of scale wind and solar projects. Private equity funds have dominated the equity investment scene. the investment would be Nine percent calculated as 10/ (100+10). However, if in the future the Most investments are in Indian Rupees and the funds stay invested for a period of five to seven promoter is able to achieve the pre-determined milestones, the promoter's shareholding would get readjusted to 33 percent calculated as 50 / (100+50). years in the companies.61 Recently, some equity investments have been made in companies developing small-scale RE applications and projects. 4.2.2 Other Equity Investors

4.2.1 Structure of Private Equity Investments Recently, development finance institutions, such as IFC, have started providing equity funds to large and small-scale RE projects. IFC has also provided funds to private equity funds like Nereus Capital Private equity funds have been actively investing in RE projects in India since 2008. They have (a RE focused private equity fund) and SBI Macquarie Infrastructure Trust. Both these equity funds supported IPPs. In many cases, these funds invested in majority-owned RE aggregation vehicles. are active investors in India's RE sector. Such vehicles include Green Infra Private Limited (99 percent owned by IDFC Private Equity), Renew Power Ventures Private Ltd. (99 percent owned by Goldman Sachs Private Equity), and Continuum Pension funds have also invested in RE in India through private equity funds, such as the SBI Wind Energy (majority owned by Morgan Stanley Infrastructure Partners). Most equity investments Macquarie Infrastructure Trust. in Indian RE companies have been made at the parent company level, and not at the project level. Sovereign wealth funds, namely Khazanah Nasional (Malaysia) and Temasek (Singapore) which have This approach provides various exit options, such as an initial public offering (IPO), or a sale to a international exposure to the RE sector, are now actively looking for investment opportunities in strategic investor (Refer Annex H: Examples of investments in Grid connected RE projects using India's RE space. However, several limitations exist with equity finance in the country (See Box 11: Commercial Instruments). Limitations of Equity Finance for RE projects in India).

Due to the nascent stage of the Indian RE sector, most IPPs do not have significant implementation Box 11: Limitations of Equity Finance for RE Projects in India and operational experience. In order to limit their risk, private equity investors structure transactions with low upfront valuations for projects under development with “earn-outs”, which are provided to The availability of equity is heavily skewed towards companies implementing less risky technologies, such as wind and solar. Equity is also restricted to states with good policy regimes and attractive the promoters based on meeting pre-agreed milestones and asset performance. An example is the business environments. Goldman Sachs' INR 10 billion (USD 160 million) funding for Renew Power Ventures.62 (See Box 10: Earn-out based Equity Investment). The hurdle rates of equity investors for RE projects in India are high (16 to 20 percent), compared to the hurdle rates of 10 to 15 percent for similar projects in the U.S. and Europe. This means Indian developers face higher cost of equity and lower valuations.

59 Tax equity investors are those who invest in projects for tax benefits e.g., to avail accelerated depreciation A substantial portion of private equity investments in the Indian RE space is approaching five years, 60 Hurdle rate is the required rate of return for equity investors. This required rate is risk adjusted for various the normal time for making exits. Investors have not been able to find exits due to the limited risks, such as the country risk, technology risk, policy risk, etc. opportunities in the capital markets. Raising new funds is proving difficult for these organizations, as 61 In general, the life of a fund raised by a private equity is 10 years. In this period, the fund needs to repay they have not been able to provide exits, and thus returns on existing investments to their capital invested plus the return on the capital. organizations. This limits the ability of such investors to scale and fund new projects. 62 Available at http://renewpower.in/images/Press-Release.PDF, last accessed on September 13, 2013

34 PACE-D Technical Assistance Program Financing Renewable Energy in India 35 4.2 EQUITY FINANCE Box 10: Earn-out based Equity Investment

34 PACE-D Technical Assistance Program Financing Renewable Energy in India 35 Mezzanine finance instruments work like debt instruments with fixed coupon payments that last until a liquidity event65, at which point these coupons are converted into equity; thereby providing the investor an upside. Base returns (minimum guaranteed returns) range between 16 and 18 percent on capital invested, and coupon rates are between four and six percent for finance provided by international investors and 8 to 11 percent for finance provided by Indian investors. The Indian RE market has seen very few mezzanine finance transactions because of several hurdles (See Box 12: Limitations of Mezzanine Finance).

Box 12: Limitations of Mezzanine Finance

There are regulatory restrictions on international finance using these instruments: • Changes in the foreign direct investments (FDI) policy, introduced in 2011 (GOI, 2011b), prohibit the use of associated put options (option to sell to the promoters in certain pre-defined scenarios) that normally form an inherent part of the mezzanine structures to secure repayment. 4.3 MEZZANINE FINANCE • Pledging of promoter shares (also the norm for such instruments) to foreign mezzanine investors categorizes such instruments as ECB, thus, posing restrictions on the use of mezzanine Mezzanine finance is a structured debt-like instrument which often bridges the financing gap in a instruments. company's capital structure, and occupies a place between senior debt and equity, both in security and total returns. It offers flexibility to meet both the investor's and the company's requirements, and also provides medium term capital without significant ownership dilution. Mezzanine finance is 4.4 PARTIAL RISK GUARANTEE FACILITIES mostly provided in the form of convertible debentures, bonds or preference shares. Partial risk guarantee facilities assume the lenders' default risk on a part of the debt provided to the Mezzanine finance is less risky than equity for investors, as it provides fixed interest along with project. Such facilities are usually provided for a fee charged by the organization providing the principal repayment and minimum guaranteed returns to investors. It is used in situations where the guarantee, and this fee is borne by the lender. Partial risk guarantees improve a project's credit company is generating adequate cash flows to service coupon payments; the promoters are rating and reduce the perceived investment risk. They are used to encourage lending to projects that unwilling to dilute their equity stake in the company; the short term conversion options are valuable otherwise would not have been funded by FIs due to various reasons, such as the use of new (e.g. when the company is close to IPO or there is a clear exit path); or where the investors deem technologies, counterparty risk, or a lack of understanding among lenders regarding a new sector. equity investment risky. As banks increase exposure to such projects, they gain more confidence, and slowly reduce their dependence on the partial risk guarantee program. There are three noteworthy transactions in which mezzanine finance instruments were used to fund RE companies in India. In the first case, the Alternate Investment Market (AIM)63 listed wind IPP, Guarantee providers can be government bodies, development banks, and government backed FIs. Mytrah Energy, raised USD 78.5 million from IDFC Project Equity. This was followed by The decision of lenders to finance projects that are backed by partial risk guarantees is determined USD 19 million from PTC Financial Services (Mytrah, 2012). And, lastly, solar IPP Azure Power raised by the: 64 USD 13.6 million from Germany's DEG. • Creditworthiness of the guarantee provider for the part of the loan guaranteed. • Creditworthiness of the developer/project for the portion of loan not guaranteed.

63 AIM is a London Stock Exchange’s International market for smaller growing companies 64 Available at http://www.thehindubusinessline.com/companies/article2686815.ece, last accessed on September 13, 2013 65 In corporate finance, a liquidity event is an umbrella term that describes the situation where the equity of the corporation's founders and original investors is converted to cash, typically through the sale of the corporation's assets or stock or an initial public offering.

36 PACE-D Technical Assistance Program Financing Renewable Energy in India 37 Mezzanine finance instruments work like debt instruments with fixed coupon payments that last until a liquidity event65, at which point these coupons are converted into equity; thereby providing the investor an upside. Base returns (minimum guaranteed returns) range between 16 and 18 percent on capital invested, and coupon rates are between four and six percent for finance provided by international investors and 8 to 11 percent for finance provided by Indian investors. The Indian RE market has seen very few mezzanine finance transactions because of several hurdles (See Box 12: Limitations of Mezzanine Finance).

Box 12: Limitations of Mezzanine Finance

36 PACE-D Technical Assistance Program Financing Renewable Energy in India 37 Partial risk guarantees also act as tools for credit enhancement. The enhanced creditworthiness 4.4.2 Partial Risk Guarantee Programs provides the following benefits: In India, risk guarantee programs for RE projects are limited. Those that do exist are described • Improves the ability of the project/developer to raise debt. below: • Improves terms of lending, such longer tenure, lower interest rate, and/or less collateral. ADB's India Solar Generation Guarantee Facility

While partial risk guarantees can be effective tools to incentivize large-scale deployment and ADB has a USD 150 million partial risk guarantee program for solar projects with government backed 66 financing of RE, very few such programs are available to developers in India. PPAs. FIs can avail of this facility until April 2014. Under this facility, ADB provides risk guarantees under these two options:

4.4.1 Structure of Partial Risk Guarantee Facilities • 50 percent of the payment default risk for entire tenure of loan.

Under a partial risk guarantee program, the project developer borrows funds from a FI to construct • Zero percent of payment default risk for the first seven years, and 95 percent to 100 percent the project. The organization providing the partial risk guarantee gives a guarantee to the FI for of default risk during the remaining tenure of the loan. repayment of a portion or full amount of the debt. It charges a fee on the amount guaranteed. In ADB has partnered with L&T Infrastructure Finance (L&T Infra) and Singapore-based Norddeutsche case the project developer is unable to service the interest and principal repayment, the guarantee Landesbank (NORD/LB) to fund solar projects with capacities below 25 MW in India. Under this is invoked and the obligation to the FI is fulfilled by the guaranteeing organization (See Figure 3: arrangement, L&T Infra and NORD/LB will provide loans to solar projects, and ADB will provide a Structure of Partial Risk Guarantee Facilities). partial risk guarantee to L&T Infra and NORD/LB. ADB in turn collects a guarantee fee (ranges between 1.5 and 2.5 percent) from L&T Infra and NORD/LB.

As of June 2012, two solar projects with capacities of 25 MW and 10 MW have been funded using Figure 3: Structure of Partial Risk Guarantee Facilities ADB's guarantee facility. The facility has had limited success and has been constrained by the lack of partner FIs.67

Credit World Bank Group's Partial Risk Sharing Program Guaranteing 68 Developer Agency The World Bank Group (WBG) provides partial risk and credit guarantee products to support projects taken up by governments and private investors in developing countries.69 The objective of Provide credit guarantee these products is to promote capital inflow into infrastructure development. WBG has also provided Credit (Services portion of debt support internationally for clean energy projects through these guarantee instruments. However, this Equity guarantee fee in case of default by the facility has not been used by Indian FIs. project company) Debt EXIM Banks Financial Project Company Institution In some cases, EXIM banks provide loan guarantees for projects using equipment manufactured in (Lender) their country. The guarantees cover commercial and political risk; the extent of risk coverage Interest payment + Debt repayment depends on the particular agency. For example, 100 percent of the commercial and political risks are

66 Available at http://www.adb.org/site/private-sector-financing/india-solar-generation-guarantee-facility, last accessed on September 13, 2013 67 Available at http://www.scribd.com/doc/97619512/Don-Purka-Solar-Power-in-India-ADB%E2%80%99s- Guarantee-Facility-and-Technical-Assistance-Program, last accessed on September 13, 2013 68 World Bank, International Finance Corporation (IFC), International Bank for Reconstruction and Development (IBRD), International Development Association (IDA), Multilateral Investment Guarantee Agency (MIGA) 69 Available at http://treasury.worldbank.org/bdm/pdf/Brochures/WBG_Guarantees_Matrix.pdf, last accessed on September 13, 2013

38 PACE-D Technical Assistance Program Financing Renewable Energy in India 39 Partial risk guarantees also act as tools for credit enhancement. The enhanced creditworthiness 4.4.2 Partial Risk Guarantee Programs provides the following benefits: In India, risk guarantee programs for RE projects are limited. Those that do exist are described • Improves the ability of the project/developer to raise debt. below: • Improves terms of lending, such longer tenure, lower interest rate, and/or less collateral. ADB's India Solar Generation Guarantee Facility

4.4.1 Structure of Partial Risk Guarantee Facilities • 50 percent of the payment default risk for entire tenure of loan.

38 PACE-D Technical Assistance Program Financing Renewable Energy in India 39 covered by U.S. EXIM70, whereas Garanti-instituttet for eksportkreditt (GIEK)71 covers 90 percent of 4.5.1 Case Study 1: Husk Power Systems the commercial risk and 100 percent of the political risk72. Husk Power Systems, a Patna-based rural empowerment enterprise, installs biomass gasification The extent of guarantee is mostly restricted to the value of exported material. However, in some based micro-grids with capacities ranging from 25 kW to 100 kW, mostly in the state of Bihar. Husk cases where the value of the exported material forms a major part (over 60 percent) of the project, Power's business model has transformed over time. From its initial focus on a BOOM (build-own- these banks may provide the guarantee on the full debt component of the project. Such guarantees operate-maintain) model, it graduated to a BOM (build-operate-maintain) model, and finally to a BM are usually provided to domestic banks (in the country of the EXIM bank), or international banks with (build-maintain) model. Although the main source of fuel for these projects is rice husk, multi-fuel presence in the EXIM bank's country. For instance, ACME Solar Technology raised USD 19 million in gasifiers are also being used. A typical plant serves two to four villages within a radius of 1.5 the form of a fixed interest rate loan with tenure of 12 years from PNC Bank (based in Pittsburgh, U.S.). It was meant for the implementation of a 15 MW solar project in the state of Gujarat in India kilometres and employs local villagers for plant operations. The company employs a pre-paid system using solar modules manufactured by First Solar, a U.S.-based solar module manufacturer. The U.S. to recover tariff from the villagers. EXIM provided a loan guarantee on the full debt provided by PNC Bank to the project.73 Though capable of supporting investments in the nascent stages of a sector, the partial risk guarantee Husk Power has secured multiple rounds of financing; however, the common theme for financing programs have some limitations (See Box 13: Limitations of Partial Risk Guarantee Programs in has been social impact rather than financial returns for the bulk of the investors (Refer Annex I: India). Finance raised by Husk Power Systems). Impact investors consider social impacts as key to making Box 13: Limitations of Partial Risk Guarantee Programs in India investment decisions, do not need quick exits and have lower return expectations. Husk Power also uses the MNRE subsidy. While partial risk guarantee programs cover (in part or full) the risk associated with a developer defaulting on part or full of the outstanding loan to FIs, RBI guidelines classify such defaults74 as non- performing assets of banks. This reflects negatively on the performance of the banks as well as the 4.5.2 Case Study 2: Saran Renewable Energy credit managers. Saran Renewable Energy, a Saran-based company promoted by a group of agriculturalists and Partial Guarantee for Investment entrepreneurs, generates electricity from renewable raw materials, such as agricultural waste USAID's Development Credit Authority has partnered with a U.S.-based institutional investor biomass. The company is in the process of setting up micro grids based on biomass gasification in Northern Lights Capital Group to facilitate a USD 100 million investment in India's clean energy Bihar and Uttar Pradesh, totalling 3 MW. sector via Nereus Capital.75 USAID will provide a 40 percent credit guarantee for a USD 100 million Alternative Energy Fund managed by Northern Lights Capital Group. The partnership is the first such The company set up its first plant of 120 kW in 2006 in Garkha village located in the Saran district of guarantee facility with a private investment fund to facilitate targeted investment. Bihar. The total cost of the project was INR 8.3 million (USD 133,000), of which INR 2 million (USD 32,000) was raised as a loan from ICICI Bank and INR 1.8 million (USD 29,000) was committed by 4.5 RURAL OFF-GRID FINANCING MNRE as capital subsidy. The balance was funded by the company through equity. However, only Rural off-grid RE projects are typically set up using a combination of government subsidies, INR 0.6 million (USD 96,000) out of the INR 1.8 million subsidy (USD 29,000) has been received by grants/investments from impact investors, and in some cases small loans (about 10 to 20 percent) the company so far. The Garkha project supplies electricity to rural consumers at a price of INR 7.50 from FIs. Very few projects receive significant commercial-grade financing. Conventional sources of per kWh (US cents 12 per kWh) (Winrock, 2012). funds will become more prevalent to this sector as the sector matures. The following three case studies illustrate different modalities for financing off-grid RE projects in India. Apart from the Garkha project, Saran Renewable Energy has set up two more plants with a capacity of 80 kW in the Itwan and Bhatgain villages in district of Saran. The company attracted funding from 70 Available at http://www.exim.gov/products/loanguarantee/, last accessed on September 13, 2013 non-resident Indians (NRIs) who have roots in these villages. A domestic private equity (name 71 Norwegian EXIM Bank 72 Available at http://www.giek.no/en/slik_gjor_vi_det/for_eksportorer, last accessed on September 13, 2013 withheld) also invested INR 60 million (USD 960,000) in the firm in 2010 in exchange for a 46 76 73 Available at http://www.exim.gov/newsandevents/releases/2011/ex-im-bank-supports-u-s-renewable-energy- percent ownership stake in the company. jobs-by-financing-solar-power-projects-in-india.cfm, last accessed on September 13, 2013 74 A debt obligation where the borrower has not paid any previously agreed upon interest and principal 76 Available at http://economictimes.indiatimes.com/opinion/india-emerging/saran-renewable-energy-is-bringing- repayments to the designated lender for an extended period of time. power-to-the-people-in-bihar/articleshow/6203318.cms, last accessed on September 13, 2013 75 Available at http://www.usaid.gov/news-information/press-releases/first-its-kind-investment-guarantee-100- million-clean-energy-india, last accessed on September 13, 2013

40 PACE-D Technical Assistance Program Financing Renewable Energy in India 41 covered by U.S. EXIM70, whereas Garanti-instituttet for eksportkreditt (GIEK)71 covers 90 percent of 4.5.1 Case Study 1: Husk Power Systems the commercial risk and 100 percent of the political risk72. Husk Power Systems, a Patna-based rural empowerment enterprise, installs biomass gasification The extent of guarantee is mostly restricted to the value of exported material. However, in some based micro-grids with capacities ranging from 25 kW to 100 kW, mostly in the state of Bihar. Husk cases where the value of the exported material forms a major part (over 60 percent) of the project, Power's business model has transformed over time. From its initial focus on a BOOM (build-own- these banks may provide the guarantee on the full debt component of the project. Such guarantees operate-maintain) model, it graduated to a BOM (build-operate-maintain) model, and finally to a BM are usually provided to domestic banks (in the country of the EXIM bank), or international banks with (build-maintain) model. Although the main source of fuel for these projects is rice husk, multi-fuel presence in the EXIM bank's country. For instance, ACME Solar Technology raised USD 19 million in gasifiers are also being used. A typical plant serves two to four villages within a radius of 1.5 the form of a fixed interest rate loan with tenure of 12 years from PNC Bank (based in Pittsburgh, U.S.). It was meant for the implementation of a 15 MW solar project in the state of Gujarat in India kilometres and employs local villagers for plant operations. The company employs a pre-paid system using solar modules manufactured by First Solar, a U.S.-based solar module manufacturer. The U.S. to recover tariff from the villagers. EXIM provided a loan guarantee on the full debt provided by PNC Bank to the project.73 Though capable of supporting investments in the nascent stages of a sector, the partial risk guarantee Husk Power has secured multiple rounds of financing; however, the common theme for financing programs have some limitations (See Box 13: Limitations of Partial Risk Guarantee Programs in has been social impact rather than financial returns for the bulk of the investors (Refer Annex I: India). Finance raised by Husk Power Systems). Impact investors consider social impacts as key to making Box 13: Limitations of Partial Risk Guarantee Programs in India investment decisions, do not need quick exits and have lower return expectations. Husk Power also uses the MNRE subsidy. While partial risk guarantee programs cover (in part or full) the risk associated with a developer defaulting on part or full of the outstanding loan to FIs, RBI guidelines classify such defaults74 as non- performing assets of banks. This reflects negatively on the performance of the banks as well as the 4.5.2 Case Study 2: Saran Renewable Energy credit managers. Saran Renewable Energy, a Saran-based company promoted by a group of agriculturalists and Partial Guarantee for Investment entrepreneurs, generates electricity from renewable raw materials, such as agricultural waste USAID's Development Credit Authority has partnered with a U.S.-based institutional investor biomass. The company is in the process of setting up micro grids based on biomass gasification in Northern Lights Capital Group to facilitate a USD 100 million investment in India's clean energy Bihar and Uttar Pradesh, totalling 3 MW. sector via Nereus Capital.75 USAID will provide a 40 percent credit guarantee for a USD 100 million Alternative Energy Fund managed by Northern Lights Capital Group. The partnership is the first such The company set up its first plant of 120 kW in 2006 in Garkha village located in the Saran district of guarantee facility with a private investment fund to facilitate targeted investment. Bihar. The total cost of the project was INR 8.3 million (USD 133,000), of which INR 2 million (USD 32,000) was raised as a loan from ICICI Bank and INR 1.8 million (USD 29,000) was committed by 4.5 RURAL OFF-GRID FINANCING MNRE as capital subsidy. The balance was funded by the company through equity. However, only Rural off-grid RE projects are typically set up using a combination of government subsidies, INR 0.6 million (USD 96,000) out of the INR 1.8 million subsidy (USD 29,000) has been received by grants/investments from impact investors, and in some cases small loans (about 10 to 20 percent) the company so far. The Garkha project supplies electricity to rural consumers at a price of INR 7.50 from FIs. Very few projects receive significant commercial-grade financing. Conventional sources of per kWh (US cents 12 per kWh) (Winrock, 2012). funds will become more prevalent to this sector as the sector matures. The following three case studies illustrate different modalities for financing off-grid RE projects in India. Apart from the Garkha project, Saran Renewable Energy has set up two more plants with a capacity of 80 kW in the Itwan and Bhatgain villages in district of Saran. The company attracted funding from 70 Available at http://www.exim.gov/products/loanguarantee/, last accessed on September 13, 2013 non-resident Indians (NRIs) who have roots in these villages. A domestic private equity (name 71 Norwegian EXIM Bank 72 Available at http://www.giek.no/en/slik_gjor_vi_det/for_eksportorer, last accessed on September 13, 2013 withheld) also invested INR 60 million (USD 960,000) in the firm in 2010 in exchange for a 46 76 73 Available at http://www.exim.gov/newsandevents/releases/2011/ex-im-bank-supports-u-s-renewable-energy- percent ownership stake in the company. jobs-by-financing-solar-power-projects-in-india.cfm, last accessed on September 13, 2013 74 A debt obligation where the borrower has not paid any previously agreed upon interest and principal 76 Available at http://economictimes.indiatimes.com/opinion/india-emerging/saran-renewable-energy-is-bringing- repayments to the designated lender for an extended period of time. power-to-the-people-in-bihar/articleshow/6203318.cms, last accessed on September 13, 2013 75 Available at http://www.usaid.gov/news-information/press-releases/first-its-kind-investment-guarantee-100- million-clean-energy-india, last accessed on September 13, 2013

40 PACE-D Technical Assistance Program Financing Renewable Energy in India 41 4.5.3 Case Study 3: Mera Gao Power Barriers to Renewable Energy Mera Gao Power builds, owns and operates low cost, energy efficient solar based micro-grids in 5 Uttar Pradesh. As of September, 2013, the firm has constructed lighting utilities in over 500 villages Finance in India in the Sitapur district, Uttar Pradesh. It currently serves 13,000 households.77 India has set an ambitious RE target of adding 30 GW to the existing 29 GW capacity by 2017. Mera Gao Power is a for-profit organization and received a grant of USD 300,000 from USAID.78 In Substantial investments are required to meet this target. To get these investments, there is a need addition to this, the two founders have brought in seed capital of USD 30,000. The company also to create enabling frameworks that can attract substantial foreign and domestic capital to the sector. uses MNRE's 30 percent subsidy for rural solar off-grid projects. Though RE has been funded for past 20 years, several challenges still exist, which are limiting capital inflow and the scale up of RE investments. This section summarizes the main challenges confronting RE financing in India. The challenges are segregated into three categories: (i) policy; (ii) business risk; and (iii) other sector specific challenges.

5.1 POLICY LEVEL BARRIERS

This section identifies the key policy-related barriers that have constrained the development of the RE market in India. These barriers have emerged either as a result of the absence of appropriate policies and regulations or the limited impact of existing ones.

77 Available at http://meragaopower.com/news/, last accessed on September 13, 2013 78 Available at http://meragaopower.com/partners-2/, last accessed on September 13, 2013

42 PACE-D Technical Assistance Program Mera Gao Power Financing Renewable Energy in India 43 4.5.3 Case Study 3: Mera Gao Power Barriers to Renewable Energy Mera Gao Power builds, owns and operates low cost, energy efficient solar based micro-grids in 5 Uttar Pradesh. As of September, 2013, the firm has constructed lighting utilities in over 500 villages Finance in India in the Sitapur district, Uttar Pradesh. It currently serves 13,000 households.77 India has set an ambitious RE target of adding 30 GW to the existing 29 GW capacity by 2017. Mera Gao Power is a for-profit organization and received a grant of USD 300,000 from USAID.78 In Substantial investments are required to meet this target. To get these investments, there is a need addition to this, the two founders have brought in seed capital of USD 30,000. The company also to create enabling frameworks that can attract substantial foreign and domestic capital to the sector. uses MNRE's 30 percent subsidy for rural solar off-grid projects. Though RE has been funded for past 20 years, several challenges still exist, which are limiting capital inflow and the scale up of RE investments. This section summarizes the main challenges confronting RE financing in India. The challenges are segregated into three categories: (i) policy; (ii) business risk; and (iii) other sector specific challenges.

5.1 POLICY LEVEL BARRIERS

77 Available at http://meragaopower.com/news/, last accessed on September 13, 2013 78 Available at http://meragaopower.com/partners-2/, last accessed on September 13, 2013

42 PACE-D Technical Assistance Program Mera Gao Power Financing Renewable Energy in India 43 Feed-in Tariffs have been poor enforcement, uneven cash-flows for generators, irrational floor prices for solar RECs, lack of price certainty post 2017, and constraints in trading and managing liquidity for RECs. FiTs are one of the most successful and effective policy instruments globally for promoting RE To encourage investments through the REC mechanism, there is a need to ensure enforcement of generation. However, FiTs have to be designed carefully, keeping in view the prevailing market RPOs and assure consistent demand and stable prices for RECs. conditions, state of technology development, and availability of resources. If the FiT is too high, it leads to unwarranted profits for developers, while if set too low, the FiT can lead to very low Accelerated Depreciation financial returns leading to low investments in the sector. Given that accelerated depreciation can only be utilized by profit-making entities with appreciable tax Experience shows that the FiTs designed by certain SERCs have been unable to attract investments. liabilities and cannot be transferred, it effectively excludes most IPPs and investors who plan on There is a need for adoption of more robust processes and methodologies for determining FiTs that using a SPV route for project development. This limits the impact of the instrument and constrains include detailed due diligence on costs and performance parameters of various technologies, so as the level of investment entering the sector. to make these attractive for both debt and equity investors. Development Approvals and Risks Reverse Bidding Wind, biomass and solar projects typically require fewer approvals than conventional energy Reverse bidding led to a significant decline in solar power procurement prices. However, it has also projects. Small hydro projects however require many government approvals, and long development led to concerns about the long-term viability of projects that actually qualified. Almost half of the cycle times (more than 3 years). This leads to an escalation in costs. For example, obtaining 79 projects that needed project financing from FIs were not able to get such financing. As a result, clearances and getting access to evacuation infrastructure has been reported to take over 60 these projects had to utilize either equity financing or balance sheet financing. For example, FIs percent of the time required to develop a project from its concept to its commissioning. Last year, were extremely concerned about the bid out tariffs on several of the projects and were unwilling to even solar and wind projects faced challenges due to long permitting processes, land acquisition finance as they felt that they were unviable for commercial finance. Reverse bidding led to issues, and community tensions. competition in an environment where capital costs, technology performance and access to financing Indian Electricity Grid Code (IEGC) 2010 were uncertain. Besides the issues around unviable bids, reverse bidding suffers from some other disadvantages: Under the IEGC 2010, RE projects will be required to forecast and schedule their power supply to the grid and are subjected to pay additional charges in case of slippage (GOI, 2010b). Since RE is • Capacity addition becomes episodic, dependent on government auctions, and as a result infirm in nature except for technologies such as biomass, significant capacity building and developers are unable to create project pipelines and leverage economies of scale. investments will be required for forecasting and scheduling by developers and DISCOMs. • Reverse bidding also reduces the interest of private equity investors, as ability to scale up appears uncertain. Open Access

• A number of states have been negotiating with the developers to match their tariffs with the Third party power sales by RE projects are charged an open access levy, which includes a cross lowest tariff discovered through the reverse bidding process. This process has delayed the subsidy surcharge and an electricity duty (except in states where these have been exempted). The project allocation and also made projects unviable for some developers. levy of these charges makes third party sales more expensive.

Renewable Purchase Obligations and Renewable Energy Certificates

The RPO and the REC regime were designed to provide market-based instruments to stimulate RE investments. However lack of RPO enforcement has led to weak markets for RECs and a loss of credibility for similar market-based mechanisms. The key limitations of the RPO and REC schemes 79 The term “evacuation” in the power system refers to the ability to connect a generator to the grid and send the power from the project into to the grid transmission and distribution system.

44 PACE-D Technical Assistance Program Financing Renewable Energy in India 45 Feed-in Tariffs have been poor enforcement, uneven cash-flows for generators, irrational floor prices for solar RECs, lack of price certainty post 2017, and constraints in trading and managing liquidity for RECs. FiTs are one of the most successful and effective policy instruments globally for promoting RE To encourage investments through the REC mechanism, there is a need to ensure enforcement of generation. However, FiTs have to be designed carefully, keeping in view the prevailing market RPOs and assure consistent demand and stable prices for RECs. conditions, state of technology development, and availability of resources. If the FiT is too high, it leads to unwarranted profits for developers, while if set too low, the FiT can lead to very low Accelerated Depreciation financial returns leading to low investments in the sector. Given that accelerated depreciation can only be utilized by profit-making entities with appreciable tax Experience shows that the FiTs designed by certain SERCs have been unable to attract investments. liabilities and cannot be transferred, it effectively excludes most IPPs and investors who plan on There is a need for adoption of more robust processes and methodologies for determining FiTs that using a SPV route for project development. This limits the impact of the instrument and constrains include detailed due diligence on costs and performance parameters of various technologies, so as the level of investment entering the sector. to make these attractive for both debt and equity investors. Development Approvals and Risks Reverse Bidding Wind, biomass and solar projects typically require fewer approvals than conventional energy Reverse bidding led to a significant decline in solar power procurement prices. However, it has also projects. Small hydro projects however require many government approvals, and long development led to concerns about the long-term viability of projects that actually qualified. Almost half of the cycle times (more than 3 years). This leads to an escalation in costs. For example, obtaining 79 projects that needed project financing from FIs were not able to get such financing. As a result, clearances and getting access to evacuation infrastructure has been reported to take over 60 these projects had to utilize either equity financing or balance sheet financing. For example, FIs percent of the time required to develop a project from its concept to its commissioning. Last year, were extremely concerned about the bid out tariffs on several of the projects and were unwilling to even solar and wind projects faced challenges due to long permitting processes, land acquisition finance as they felt that they were unviable for commercial finance. Reverse bidding led to issues, and community tensions. competition in an environment where capital costs, technology performance and access to financing Indian Electricity Grid Code (IEGC) 2010 were uncertain. Besides the issues around unviable bids, reverse bidding suffers from some other disadvantages: Under the IEGC 2010, RE projects will be required to forecast and schedule their power supply to the grid and are subjected to pay additional charges in case of slippage (GOI, 2010b). Since RE is • Capacity addition becomes episodic, dependent on government auctions, and as a result infirm in nature except for technologies such as biomass, significant capacity building and developers are unable to create project pipelines and leverage economies of scale. investments will be required for forecasting and scheduling by developers and DISCOMs. • Reverse bidding also reduces the interest of private equity investors, as ability to scale up appears uncertain. Open Access

Renewable Purchase Obligations and Renewable Energy Certificates

44 PACE-D Technical Assistance Program Financing Renewable Energy in India 45 5.2 MARKET BASED BARRIERS Community Risk

RE technologies face a number of market-based barriers. These include off-taker risks, technology Land acquisition is increasingly becoming a challenge for RE capacities. Land is typically procured and resource risks, barriers in accessing evacuation infrastructure, and acceptance by local after the permitting process, which can take significant time. By this time, local communities communities where the projects are sited. Some of these have been described in the paragraphs become aware that a project requires their land and can drive up its price thereby delaying land below: acquisition. Small hydro projects have faced delays due to community protests, as the rivers in which these projects are based or are nearby are considered sacred, or due to problems with water Off-taker Risk diversion, an important resource in hilly areas.

The creditworthiness of the off-taker (the state distribution companies in the case of sales to the Lack of Exit Options for Existing Investors state) plays a key role in determining the bankability of a PPA. Very few DISCOMs, such as those in Gujarat and Maharashtra, are in good financial health. In other states, DISCOMs have poor financial A substantial portion of private equity investments in the Indian RE space is approaching five years, health, and the risk of off-taker default and delayed payments is high (for example, developers have the normal time for making exits. Investors have not been able to find exits due to the limited receivables of up to 12 months in states like Rajasthan and Tamil Nadu). opportunities in the capital markets. Raising new funds is proving difficult for these organizations, as they have not been able to provide exits, and thus returns on existing investments to their Fuel Risk organizations. This limits the ability of such investors to scale and fund new projects.

Fuel risk is high for biomass projects (except for captive projects that use by-products as fuel) as 5.3 BARRIERS TO RURAL OFF-GRID PROJECTS these projects are competing for fuel with several alternative uses; and which has to be procured from a variety of producers (who are reluctant to enter into long term supply agreements). There are numerous barriers to financing off-grid rural RE projects in India. Challenges exist for both debt and equity investors, as discussed below: Technology Risk Small Ticket Size of Transaction Banks consider relatively newer technologies riskier, especially those with high technology design requirements such as CSP and biomass (using new feedstocks such as rice stalk and poultry litter). Off-grid projects are mostly small in size and the capital requirements per project are also very The perception of risk is due to their unfamiliarity with the technology and poor performance of small. Unless there is a large corporate entity implementing a portfolio of such projects, the earlier projects. investment size usually falls below the minimum size of investment required by most FIs. Such projects find it hard to garner the interest of most lenders and equity investors. Evacuation Risk Limited Penetration of Financial Institutions in Rural Areas Evacuation is a generic problem afflicting wind, solar and the small hydro sector. Lack of adequate evacuation facilities has led to scaling back the commissioning and partial commissioning of new Most FIs have limited presence in rural areas. They are not as well connected to local communities generation and the reduction of generation during peak periods. This issue is constraining the and businesses in rural areas, which is crucial for establishing trust with local entrepreneurs. development of small hydro projects across the northern states (such as Himachal Pradesh and Small Size of Projects makes it Difficult for Promoters to Exit Uttarakhand) and northeastern states, solar development in the remote areas of Rajasthan, and wind in Tamil Nadu. Banks and financial institutions are more cautious lending to RE projects given the Companies that are into the business of owning and operating off-grid projects find it difficult to poor state of the evacuation networks. This risk is high where there is a lack of evacuation capacity scale-up operations due to the distributed nature of demand, the small size of projects, and the such as Tamil Nadu and Rajasthan, while the risk is low in states such as Gujarat. operational issues associated with each project. Equity investors find it difficult to exit through traditional routes, such as an IPO or a buyout from a strategic investor.

46 PACE-D Technical Assistance Program Financing Renewable Energy in India 47 5.2 MARKET BASED BARRIERS Community Risk

46 PACE-D Technical Assistance Program Financing Renewable Energy in India 47 Lack of Successful Scalable, Replicable Business Models 5.4 BARRIERS TO COMMERCIAL OFF-GRID PROJECTS

Only a few examples of successful business models for off-grid RE projects exist in India. For those Commercial projects, like off-grid rural electrification projects, face a number of barriers which that do exist, the scope for replication is limited, as conditions relating to RE resource, off taker impact their bankability: risks, and local support differ from one area to another. Project operators find it difficult to enter into Small Ticket Size of Transaction or enforce long-term contracts with local communities for either procurement of fuel or aggregation of demand. Commercial off-grid projects are small in size (normally a few 100 kWs), and do not gain much attention from equity investors and lenders. They are not financed unless the user borrows directly Limited Understanding of Off-grid Projects among Financers and Investors based on its balance sheet and existing relationship with a bank. Most investors and lending institutions lack the understanding and ability to assess risks inherent to Small Size of RESCOs off-grid projects. This makes it much more difficult to effectively analyze and prepare the project proposal for review by potential investors or by a bank's credit committee. RESCOs that own and operate off-grid projects and sell power to consumers are small in size and find it difficult to attract funding from banks because of their limited balance sheets. Viability Concerns due to High Upfront Costs Off-taker Risk The initial cost per kW of off-grid systems is much higher than grid connected projects due to their small size and the additional investment required for distribution. This keeps the returns for such Since these projects sell electricity directly to industrial and commercial customers, off-taker risk is projects low and acts as a deterrent to financing. inherent and the creditworthiness of the off-taker plays a key role in determining the bankability of these projects. Banks also find it difficult to look at these projects as a portfolio. Long Gestation Period for Release of Capital Subsidy Additional Costs for Availing RECs The GOI does provide subsidies to off-grid projects, but it usually takes a long time for approval and disbursement. This puts additional stress on off-grid RE projects, significantly reduces the rate of The current REC framework does not differentiate the projects developed for 100 percent on site success, and extends the time for financial closure (off-grid) captive consumption from projects developed to inject electricity into the grid. To make projects eligible for RECs, these projects need to be connected to the grid. This leads to additional Threat from Extension of the Grid cost of connecting to the grid such as additional infrastructure and open access charges. There is a high degree of uncertainty around the future of off-grid RE projects once those areas get 5.5 GAPS AND NEEDS IN RE FINANCING electrified through grid extension. The likelihood of future grid-connection, its impact on an off-grid project, and alternative options once it does happen need to be addressed specifically by the project Based on discussions with developers, lenders, investors and experts in RE finance, including the developer in discussions with investors. Advisory Team for RE Finance (ATREF) created by PACE-D TA Program, the following key gaps in RE financing have been identified: Summing up, the key problem with off grid projects is 'small scale'. RESCOs with larger access to demand and special funding support can attack this problem. This report proposes a special Off Grid • Growth of IPPs is an important development as IPPs can scale up RE investments. However Fund to support RESCOs, discussed in detail in chapter 6. IPPs need new financial constructs to scale up o New Sources of funds , Large investors such as pension funds, insurance companies, sovereign wealth funds, family funds, CSR funds and Islamic finance.

48 PACE-D Technical Assistance Program Financing Renewable Energy in India 49 Lack of Successful Scalable, Replicable Business Models 5.4 BARRIERS TO COMMERCIAL OFF-GRID PROJECTS

48 PACE-D Technical Assistance Program Financing Renewable Energy in India 49 , Access to capital markets. Figure 4: Suggested Financial Mechanisms , Participation by individual investors. o Participation by International investors to meet larger investment needs of the future. • Pension funds o Mainstream debt financing options which allow longer term, low cost debt to be • HNIs, CSR Funds available at higher leverage. • International capital for • Availability of financial products suitable for each stage of project development (e.g. pre- sustainability construction, construction, post commissioning). This eases migration from one type of financing to the next as risks are reduced. New sources • Appropriate policies so that all classes of investors can benefit from incentives such as accelerated depreciation, tax holidays, RECs, and subsidies.80 • Tenure over 15 yrs • Institutional arrangements and policies to help scale up of RESCOs through access to equity • Lower interest rates • Transferable benefits and debt. • Higher • Pass-through tax Debt-equity Wider • Mechanisms and products to reduce risks of RE investments. Infra Financing access to structures ratio financing needs Figure 4 depicts these needs and related measures. tax benefits

• Risk insurance • Re-financing existing debts Reduce risks • Supportive policy instruments; Effective market mechanisms; Removal of direct subsidies

80 At present these benefits can be utilized by only a certain class of investors. For example only corporates setting up captive plants can take full benefit of accelerated depreciation. Or REC benefits can’t be aggregated and be available to all investor classes.

50 PACE-D Technical Assistance Program Financing Renewable Energy in India 51 , Access to capital markets. Figure 4: Suggested Financial Mechanisms , Participation by individual investors. o Participation by International investors to meet larger investment needs of the future. • Pension funds o Mainstream debt financing options which allow longer term, low cost debt to be • HNIs, CSR Funds available at higher leverage. • International capital for • Availability of financial products suitable for each stage of project development (e.g. pre- sustainability construction, construction, post commissioning). This eases migration from one type of financing to the next as risks are reduced. New sources • Appropriate policies so that all classes of investors can benefit from incentives such as accelerated depreciation, tax holidays, RECs, and subsidies.80 • Tenure over 15 yrs • Institutional arrangements and policies to help scale up of RESCOs through access to equity • Lower interest rates • Transferable benefits and debt. • Higher • Pass-through tax Debt-equity Wider • Mechanisms and products to reduce risks of RE investments. Infra Financing access to structures ratio financing needs Figure 4 depicts these needs and related measures. tax benefits

• Risk insurance • Re-financing existing debts Reduce risks • Supportive policy instruments; Effective market mechanisms; Removal of direct subsidies

50 PACE-D Technical Assistance Program Financing Renewable Energy in India 51 Suggestions for Innovative Financing 6 Mechanisms for RE in India

To scale up its RE capacity, India will need significant financial investments. A number of large financing sources still need to be tapped for RE. However, access to finance has been constrained by a number of barriers such as tax benefits not uniformly accessible to potential investors; limited access to capital markets; constrained private equity inflows; asset liability mismatch, etc. Overcoming these barriers has the potential to facilitate the required inflow of investments to scale up the RE sector in India.

This report presents seven innovative financing mechanisms that can be adapted for implementation in India to support scaling up of RE investments. The mechanisms can be classified as fiscal, policy or financial mechanisms.

1. Fiscal a. Tax efficient trusts such as Master Limited Partnerships, Business Trusts, and Real Estate Investment Trusts b. Tradable tax credits

Financing Renewable Energy in India 53 Suggestions for Innovative Financing 6 Mechanisms for RE in India

1. Fiscal a. Tax efficient trusts such as Master Limited Partnerships, Business Trusts, and Real Estate Investment Trusts b. Tradable tax credits

Financing Renewable Energy in India 53 Figure 5: Typical Structure of a Business Trust 2. Policy a. REC Market Maker 3. Financial Sponsor Public a. Green Bonds

b. Infrastructure Debt Fund D C s is a l n t p a io r it it t ib a p u c. Off-Grid Fund u l a ib t C tr io s n i d. Risk Insurance s D Trustee and Management Services Trustee The above mechanisms have been identified after researching financing products used in developed Business Trust Manager markets and analyzing their ability to address constraints. These have been presented to developers, Trustee and Management Fee investors and lenders during roundtable conferences and one-on-one meetings and have been reviewed by the ATREF. 100% 100% 100% 100%

6.1 FISCAL MECHANISMS Asset Asset Asset Asset

6.1.1 Tax Efficient Trusts for RE

Trusts and Master Limited Partnerships (MLPs) have been successfully used across the globe to A business trust structure offers a number of advantages for attracting investments for RE projects, enhance and attract investments in specific classes of assets. Trusts and MLPs are tax efficient structures that can be traded publicly and thus have access to capital market liquidity through a few of which are highlighted below: individual, retail and institutional investors. The use of such structures for RE financing (called Renewable Energy Trusts) can be very effective for attracting capital into the Indian RE market. A • Efficient extraction of cash flows from assets: A business trust, unlike a company, is number of examples of international tax efficient structures exist – one such example is the permitted to make distributions from its cash flows (instead of profits), which allows Singapore Business Trust, which is further explained below. (Refer Annex J for other structures like investors the option of taking out cash from cash generating assets like RE projects. The MLP, REIT). Company Law of India allows dividends only up to net profits, while companies may generate more free cash on account of non-cash expenses. This is especially true for RE Singapore Business Trusts projects, such as solar and wind. With the business trust structure, investors would realize A business trust is a corporate structure set up in Singapore under the Business Trust Act, 2004. At better returns as the entire free cash generated by the projects can be distributed to the present, there are nine business trusts listed on the Singapore Exchange, one of which, is the investors. Hutchison Port Holdings Trust, undertook the largest IPO in Singapore's history by raising approximately SGD 7 billion (USD 5.6 billion).81 Several companies have taken the Singapore • Continued control over trust assets: Sponsors typically own the trust manager and retain a Business Trust route for attracting investments in RE (See Annexure K: Companies adopting controlling stake in the business trust. Even post IPO, sponsors continue to hold more than Singapore Business Trust Route). 25 percent units in the business trust. This makes removal of trust managers difficult as it requires approval of more than 75 percent of the unit holders, allowing better control over A business trust is managed by a trustee-manager, who is the legal owner and manager of the the trust. business trust's assets and receives remuneration for services provided (typically a fixed fee and an incentive fee tied to the performance of the business trust) (See Figure 5: Typical Structure of a • Tax free distributions: Distributions from a business trust are tax free in Singapore. This tax Business Trust). exemption is applicable to all unit holders in a business trust irrespective of their nationality, identity or tax residence status. 81 Available at http://www.hutchison-whampoa.com/hphtrust/en/p110318.htm, last accessed on September 13, 2013

54 PACE-D Technical Assistance Program Financing Renewable Energy in India 55 Figure 5: Typical Structure of a Business Trust 2. Policy a. REC Market Maker 3. Financial Sponsor Public a. Green Bonds b. Infrastructure Debt Fund D C s is a l n t p a io r it it t ib a p u c. Off-Grid Fund u l a ib t C tr io s n i d. Risk Insurance s D Trustee and Management Services Trustee The above mechanisms have been identified after researching financing products used in developed Business Trust Manager markets and analyzing their ability to address constraints. These have been presented to developers, Trustee and Management Fee investors and lenders during roundtable conferences and one-on-one meetings and have been reviewed by the ATREF. 100% 100% 100% 100%

6.1 FISCAL MECHANISMS Asset Asset Asset Asset

6.1.1 Tax Efficient Trusts for RE

54 PACE-D Technical Assistance Program Financing Renewable Energy in India 55 • Liquidity through listing: These trusts can be listed on the Singapore Exchange, and hence, What needs to be done? provide access to liquidity from capital markets. • Discuss with policy makers and assess the benefits and challenges involved in adopting 82 • Gearing : There are no legal or regulatory restrictions on gearing of business trusts. trusts. • Shariah law compliance for Islamic finance: The business trust structure is ideally suited to • Organize a knowledge exchange with the U.S. and/or Singapore regulators and the trusts attract Shariah compliant investors, as it provides stable annual returns without using any that have been listed there. debt like instruments. • Develop details of regulatory changes needed to facilitate the launch of such trusts in India. How can tax efficient trusts help? 6.1.2 Tradable Accelerated Depreciation Tax Credits Benefits Tax efficient trusts can address some of the important needs in RE financing by providing the Tradable accelerated depreciation tax credits are tax-saving certificates available to RE projects, following benefits: which are eligible for accelerated depreciation benefits. The value of these tax credits is equivalent to the value of the depreciation credit that the company holding the RE project is entitled to. • They can attract new sources of financing because they offer stable cash-flows, and long term investments for: RE investments are capital intensive with low taxable profits in the initial years. The benefit of o Large institutional investors such as pension funds, insurance companies, sovereign accelerated depreciation can only be utilized when the company owning the RE asset has enough wealth funds, and Islamic financial institutions. profits from other businesses. Thus captive generation plants owned by existing profitable o High-net-worth Individuals. businesses can take advantage of this benefit, whereas IPPs are unable to benefit because they invest in new greenfield projects and always through SPV. This anomaly is partly addressed by • They are very useful for aggregating operating assets, providing take-out finance and making GBI available to IPPs. However this approach has some disadvantages: releasing construction/development finance for further development work. • Tax pass-through benefits for investors attract many investors. • GBI puts a financing burden directly on the government • More efficient cash utilization as these trusts distribute almost the entire cash generated by • GBI payments get delayed. projects. (In normal financing mode for RE, SPVs are created and they are unable to • GBI is not available to all IPP projects. distribute cash to the parents without attracting tax penalties.) • GBI is paid at the financial year end; this causes uneven cash-flows. Challenges • GBI cannot be used to create additional debt financing as any securitization cuts down into The introduction of tax efficient trusts in India would require regulatory changes and some revisions the overall debt limit. in laws by the Ministry of Finance, Ministry of Corporate Affairs, and Ministry of New and Proposed Structure Renewable Energy in areas such as: • Pass-through status for tax benefits • Tradable accelerated depreciation tax credits will be certificates available to generators eligible for accelerated depreciation. • Channelizing international investments and their tax treatment • The certificates will be freely tradable and could be used by entities to offset their income • Distribution of cash to investors; issue of dividend distribution tax, and capital gains tax tax liabilities using the depreciation equivalent available from the certificate. • Listing of such structures on local stock exchanges • The selling price of these certificates will be market determined, but will mostly be at a 5 to • Regulations for investment managers, asset managers, and trustees 10 percent discount to the tax saving value of the certificate, so that there is an incentive for the buyer of these certificates. 82 Gearing or financial leverage is the extent to which a company relies on borrowed funds for its operations

56 PACE-D Technical Assistance Program Financing Renewable Energy in India 57 • Liquidity through listing: These trusts can be listed on the Singapore Exchange, and hence, What needs to be done? provide access to liquidity from capital markets. • Discuss with policy makers and assess the benefits and challenges involved in adopting 82 • Gearing : There are no legal or regulatory restrictions on gearing of business trusts. trusts. • Shariah law compliance for Islamic finance: The business trust structure is ideally suited to • Organize a knowledge exchange with the U.S. and/or Singapore regulators and the trusts attract Shariah compliant investors, as it provides stable annual returns without using any that have been listed there. debt like instruments. • Develop details of regulatory changes needed to facilitate the launch of such trusts in India. How can tax efficient trusts help? 6.1.2 Tradable Accelerated Depreciation Tax Credits Benefits Tax efficient trusts can address some of the important needs in RE financing by providing the Tradable accelerated depreciation tax credits are tax-saving certificates available to RE projects, following benefits: which are eligible for accelerated depreciation benefits. The value of these tax credits is equivalent to the value of the depreciation credit that the company holding the RE project is entitled to. • They can attract new sources of financing because they offer stable cash-flows, and long term investments for: RE investments are capital intensive with low taxable profits in the initial years. The benefit of o Large institutional investors such as pension funds, insurance companies, sovereign accelerated depreciation can only be utilized when the company owning the RE asset has enough wealth funds, and Islamic financial institutions. profits from other businesses. Thus captive generation plants owned by existing profitable o High-net-worth Individuals. businesses can take advantage of this benefit, whereas IPPs are unable to benefit because they invest in new greenfield projects and always through SPV. This anomaly is partly addressed by • They are very useful for aggregating operating assets, providing take-out finance and making GBI available to IPPs. However this approach has some disadvantages: releasing construction/development finance for further development work. • Tax pass-through benefits for investors attract many investors. • GBI puts a financing burden directly on the government • More efficient cash utilization as these trusts distribute almost the entire cash generated by • GBI payments get delayed. projects. (In normal financing mode for RE, SPVs are created and they are unable to • GBI is not available to all IPP projects. distribute cash to the parents without attracting tax penalties.) • GBI is paid at the financial year end; this causes uneven cash-flows. Challenges • GBI cannot be used to create additional debt financing as any securitization cuts down into The introduction of tax efficient trusts in India would require regulatory changes and some revisions the overall debt limit. in laws by the Ministry of Finance, Ministry of Corporate Affairs, and Ministry of New and Proposed Structure Renewable Energy in areas such as: • Pass-through status for tax benefits • Tradable accelerated depreciation tax credits will be certificates available to generators eligible for accelerated depreciation. • Channelizing international investments and their tax treatment • The certificates will be freely tradable and could be used by entities to offset their income • Distribution of cash to investors; issue of dividend distribution tax, and capital gains tax tax liabilities using the depreciation equivalent available from the certificate. • Listing of such structures on local stock exchanges • The selling price of these certificates will be market determined, but will mostly be at a 5 to • Regulations for investment managers, asset managers, and trustees 10 percent discount to the tax saving value of the certificate, so that there is an incentive for the buyer of these certificates. 82 Gearing or financial leverage is the extent to which a company relies on borrowed funds for its operations

56 PACE-D Technical Assistance Program Financing Renewable Energy in India 57 India has experience with the trading of tax certificates. Exporters entitled to duty exempt imports 6.2 POLICY MECHANISMS used to have the option of selling their entitlement to importers who needed duty free imports. 6.2.1 REC Market Maker The U.S. offers many transferable tax credits for investing or spending on RE. There is an online RECs are not factored-in by banks and other FIs in their evaluation of projects due to the risk of exchange for trading such incentives too. The sellers use such trading instrument to raise capital for unsold RECs. In the last twelve REC trading sessions, the number of “sell” bids was well in excess their projects. of the “buy” bids, leading to a build-up of unsold stock. In such a situation, a market making How can tradable tax credits help? organization can provide a lot of confidence to both investors and lenders, and can significantly improve the financial attractiveness of RE projects availing these benefits. The REC Market Maker Benefits (RMM) will ensure liquidity in the market for RECs.

• Credits will bring down the need for making investments, when the benefit of accelerated Structure of REC Market Maker depreciation is pursued. Such investors can buy the credit instead • The RMM will be a government sponsored body83 that will act as a buyer and seller of last • Qualified developers and operators can raise part of the project finance capital (equity) using resort in case of either unsold RECs in the market or a supply shortage in the market. the trading of such credits. This can be very useful in accelerating investments • The purchase price and sale price of RECs will be pre-established by the RMM. While RMM • Government can withdraw GBI and save on the budget burden will purchase RECs at the floor price, the sale price will be at a marginal discount to the forbearance price. • Credits will also bring all investors at par and take away differential advantages available to captive capacities. Since IPPs drive the bulk of investments, this benefit will remove a crucial • The spread in the sale and purchase price of RECs will enable the RMM to generate profits and reduce its reliance on government funds for meeting its administrative expenses and disadvantage for them and will be useful for scaling up RE investments fund requirements. • Overall such instruments will improve 'capital efficiency' • Entities eligible to sell or buy from the RMM should submit valid un-cleared sale/purchase Challenges bids in the REC trading session. • RECs possessed by the RMM may have an extended life. Accelerated depreciation has been criticized by many as it may lead to poor investment decisions. This perception may be applicable to this scheme as well, although it is designed to take care of the Other supportive roles for RMM include: same issues by supporting qualified developers. • The RMM may be authorised to buy RECs in forward transactions or develop other products What needs to be done? to improve liquidity. • The RMM may also play a role in bringing increased discipline and compliance in the market: • Discuss with policy makers (MNRE, Ministry of Finance) and assess the benefits and o Help SNAs in setting up effective monitoring mechanisms for RPO compliance. challenges involved in adopting tradable accelerated depreciation tax credits. o Develop linkages with other credits such as EE Certificates (ECERTs).84 • Identify and detail regulatory provisions needed to support tradable accelerated depreciation o As a part of its independent role for strengthening RPO mechanism, use legal means tax credits, covering issues such as who is qualified to receive them, when can they be such as appeals in Appellate Tribunal for Electricity for ensuring compliance by obligated issued, and how will they be traded. entities.

83 May be in partnership with some development financial intuitions, and structured with an independent corporate structure. 84 World Bank is working on a similar market maker scheme for ECERTs from PAT program. The RMM idea may be combined with ECERT market maker.

58 PACE-D Technical Assistance Program Financing Renewable Energy in India 59 India has experience with the trading of tax certificates. Exporters entitled to duty exempt imports 6.2 POLICY MECHANISMS used to have the option of selling their entitlement to importers who needed duty free imports. 6.2.1 REC Market Maker The U.S. offers many transferable tax credits for investing or spending on RE. There is an online RECs are not factored-in by banks and other FIs in their evaluation of projects due to the risk of exchange for trading such incentives too. The sellers use such trading instrument to raise capital for unsold RECs. In the last twelve REC trading sessions, the number of “sell” bids was well in excess their projects. of the “buy” bids, leading to a build-up of unsold stock. In such a situation, a market making How can tradable tax credits help? organization can provide a lot of confidence to both investors and lenders, and can significantly improve the financial attractiveness of RE projects availing these benefits. The REC Market Maker Benefits (RMM) will ensure liquidity in the market for RECs.

58 PACE-D Technical Assistance Program Financing Renewable Energy in India 59 o Work with CERC and Forum of Regulators to improve the regulations relating to RPO infrastructure projects due to an asset-liability mismatch. Moreover, banks also have to deal with including processes for reviewing RPO targets (dynamic adjustments) and REC floors internally set sector limits. Most private equity funds are struggling to raise new funds due to their and forbearance levels. inability to exit from existing investments, on account of the lackluster capital markets.

o Help develop schemes for weighted REC entitlements for new RE technologies or RPO Green bonds can be effectively used to solve this problem. Green bonds or climate bonds are bonds compliance weights for REC vintages to help initial investments in a new technology. issued for financing projects or programs that directly contribute towards climate change mitigation, adaptation, environmental protection, and related issues. However, in this section of the report, How can a REC Market Maker help? green bonds are referred to as asset backed bonds that refinance operational cash flow from low Benefits carbon infrastructure.

RECs are a market based mechanism that can help finance RE projects if there is greater confidence Green bonds can provide 'exits' to private equity investors as well as lenders in India by transferring on liquidity and pricing of RECs. The RMM will help create this confidence and may also help in: funds from green bond investors. This will provide fresh capital infusion to lenders for re-deployment • Strengthening the compliance mechanism as an independent player. and will enable private equities to raise fresh funds from investors. These bonds would also work as • Build markets for other environmental credits such ECERTs. Such market instruments can a means of gaining access to international capital pools to finance Indian RE projects and assets. help minimize or eliminate direct subsidies from the Government in a number of areas. Globally, two main types of structures can be used for re-financing through green bond issuance: (i) Challenges corporate bonds; and (ii) portfolio bonds. Ensuring compliance with RPO and non-uniform RPO targets across states are two of the most important challenges. Corporate Bonds

Experts feel that it is difficult to impose strict penalties on obligated entities (specifically state Corporate bonds are issued by the issuer, but verifiably linked to assets that qualify as green DISCOMs) because they are state governed and are not financially sound. Many ideas have been investments. The key features of corporate bonds include: proposed such as devolving the RPO targets directly to users and linking performance on RPOs to SEB performance rating. • Bonds are issued against issuer's credit rating.

What needs to be done? • Issuer may get a certification (e.g. from Climate Bond Standards Board) that the bond proceeds are used for refinancing green infrastructure. • Develop details of government sponsorship of the RMM with CERC and MNRE.85 • Explore development of the RMM in partnerships with development financial institutions • At the time of issuance, the asset portfolio has to have a market value greater than bond such as the World Bank and ADB. issuance value, so that there is enough incentive for buyers to purchase the bonds (the • Develop overall RPO policy reforms needed to revive the long term market for RECs. same way as IPO issues are usually underpriced). 6.3 FINANCING MECHANISMS • As the coupon is paid by underlying projects, the issuers may issue bonds with a payout lower than can generation from underlying projects to improve the credit quality of the 6.3.1 Green Bonds bonds. • The asset related risks are still carried by the issuer and are not passed on to the bond Equity investors, as well as lenders with exposure to infrastructure assets, including RE, holders. consistently try to "churn" their funds (exit existing assets and invest in new ones). NBFCs and commercial banks in India are already facing difficulties in providing long term funding for

85 For example, can RMM use National Clean Energy Fund for the initial corpus?

60 PACE-D Technical Assistance Program Financing Renewable Energy in India 61 o Work with CERC and Forum of Regulators to improve the regulations relating to RPO infrastructure projects due to an asset-liability mismatch. Moreover, banks also have to deal with including processes for reviewing RPO targets (dynamic adjustments) and REC floors internally set sector limits. Most private equity funds are struggling to raise new funds due to their and forbearance levels. inability to exit from existing investments, on account of the lackluster capital markets. o Help develop schemes for weighted REC entitlements for new RE technologies or RPO Green bonds can be effectively used to solve this problem. Green bonds or climate bonds are bonds compliance weights for REC vintages to help initial investments in a new technology. issued for financing projects or programs that directly contribute towards climate change mitigation, adaptation, environmental protection, and related issues. However, in this section of the report, How can a REC Market Maker help? green bonds are referred to as asset backed bonds that refinance operational cash flow from low Benefits carbon infrastructure.

85 For example, can RMM use National Clean Energy Fund for the initial corpus?

60 PACE-D Technical Assistance Program Financing Renewable Energy in India 61 Portfolio Bonds multilateral development banks to finance their investments in climate change mitigation and adaptation). Under the portfolio bonds mechanism, a portfolio of assets is put into a special purpose vehicle (SPV) and ring fenced. Bonds are issued on the loan portfolio. The cash flows from projects are used Some key FIs who issued green bonds are the World Bank, IFC, European Investment Bank, to service the bond. European Bank for Reconstruction and Development, ADB, and South African Industrial Development Corporation. U.K. institutions have issued the largest amount of green bonds (23 • The credit quality of the loan portfolio can be enhanced through risk mitigation measures percent), followed by France (17 percent). The EU in total has contributed 67 percent of the such as: issuances (See Figure 8: Climate Themed Bonds). Brazil is likely to be a large issuer in the future, as Brazil National Development Bank has issuance planned to support renewables, transport, building o Sector/technology diversification. and industrial energy efficiency, waste-to-energy, preventing desertification, and reduced o Insurance against policy risks, exchange risk covers, country/political risk covers, and deforestation. Chinese green bond issuance is also accelerating with issuances for efficient rail operational risk. transport, issuances by municipalities, RE companies (solar, wind), and EE. See Annex L for o Credit risk enhancements (partial/full risk guarantees) provided by organizations like examples of green bonds. ADB, World Bank, IFC, and OPIC. o Cash flows from underlying assets being higher than those required to meet the Brazil National Development Bank has issuance planned to support renewables, transport, building cash flow requirements of bond holders. and industrial energy efficiency, waste-to-energy, preventing desertification, and reduced • Portfolio bonds need to be credit rated. deforestation. Chinese green bond issuance is also accelerating with issuances for efficient rail transport, issuances by municipalities, RE companies (solar, wind), and EE. See Annex L for The recourse for bondholders is mostly the underlying assets; however, bond issuing corporates examples of green bonds. may in some cases provide additional guarantee support (corporate, government or some other financial institution). Figure 6: Climate Themed Bonds

45 Market for Green Bonds 40 There is an increasing awareness of the importance of green bonds to finance future investment in 35 clean energy. It is estimated that debt financing of USD 6 trillion or more will be needed to finance

s 30 low carbon infrastructure across the globe between 2010 and 2020 (CBI, 2012). Bonds are well n o i l l suited to finance such infrastructure projects, as bonds have a long life and low operating costs. In i 25 B

comparison, non-green infrastructure options are dependent on non-renewable sources and subject D 20 S to rapid inflation and increasing environmental costs. U 15 10 In 2011, the London-based Climate Bonds Initiative, an international investor-focused non-for-profit organization, conducted a survey to profile the issuance of green bonds (CBI, 2012). The survey 5 revealed that green bonds valuing nearly USD 174 billion were outstanding in 2011 (over 1,000 0 K e s d y ia a a issuances, 207 issuers, 82 percent issued by corporates and 13 percent issued by development c te n n s d in U n a a a s a h ra t rl u n banks). The key sectors covered by such bonds were energy (RE such as wind and solar); water; S rm a C F e R C d tz e e i G agriculture and forestry (wood products, sustainable forestry, organic seeds and fertilizers); transport it w n S (including rail transportation which is inherently low carbon); building and industrial EE (activities U such as retrofits and LED applications); waste and pollution control; and green finance (issued by Source: CBI, 2012

62 PACE-D Technical Assistance Program Financing Renewable Energy in India 63 Portfolio Bonds multilateral development banks to finance their investments in climate change mitigation and adaptation). Under the portfolio bonds mechanism, a portfolio of assets is put into a special purpose vehicle (SPV) and ring fenced. Bonds are issued on the loan portfolio. The cash flows from projects are used Some key FIs who issued green bonds are the World Bank, IFC, European Investment Bank, to service the bond. European Bank for Reconstruction and Development, ADB, and South African Industrial Development Corporation. U.K. institutions have issued the largest amount of green bonds (23 • The credit quality of the loan portfolio can be enhanced through risk mitigation measures percent), followed by France (17 percent). The EU in total has contributed 67 percent of the such as: issuances (See Figure 8: Climate Themed Bonds). Brazil is likely to be a large issuer in the future, as Brazil National Development Bank has issuance planned to support renewables, transport, building o Sector/technology diversification. and industrial energy efficiency, waste-to-energy, preventing desertification, and reduced o Insurance against policy risks, exchange risk covers, country/political risk covers, and deforestation. Chinese green bond issuance is also accelerating with issuances for efficient rail operational risk. transport, issuances by municipalities, RE companies (solar, wind), and EE. See Annex L for o Credit risk enhancements (partial/full risk guarantees) provided by organizations like examples of green bonds. ADB, World Bank, IFC, and OPIC. o Cash flows from underlying assets being higher than those required to meet the Brazil National Development Bank has issuance planned to support renewables, transport, building cash flow requirements of bond holders. and industrial energy efficiency, waste-to-energy, preventing desertification, and reduced • Portfolio bonds need to be credit rated. deforestation. Chinese green bond issuance is also accelerating with issuances for efficient rail transport, issuances by municipalities, RE companies (solar, wind), and EE. See Annex L for The recourse for bondholders is mostly the underlying assets; however, bond issuing corporates examples of green bonds. may in some cases provide additional guarantee support (corporate, government or some other financial institution). Figure 6: Climate Themed Bonds

62 PACE-D Technical Assistance Program Financing Renewable Energy in India 63 How can Green Bonds help? IDFs allow tapping of long-term, low-cost debt from insurance, pension funds, and other long-term investors (both domestic and foreign), to refinance bank debt for infrastructure projects. By Benefits refinancing, the IDFs can release a large capacity of banks to finance greenfield projects.

Green bonds can effectively tap new international sources of funds such as pension funds, In FY 2011-12, the GOI allowed IDFs to be established to ease and accelerate the flow of funds into insurance companies, and sovereign wealth funds. These types of investors are used to investing in infrastructure development projects in the country. Such funds act as pass through vehicles, with no green bonds globally. Almost 10 percent of the capital base of large investors is being allocated to tax applicable on the income generated by the IDF. To attract offshore funds into IDFs, the Finance green and sustainable investing. Such capital can be attracted to a green bond issuance. Minister has announced a reduction in the withholding tax on interest payments on the borrowings by IDFs from 20 percent to 5 percent. Green bonds will help improve the tenure and reduce the cost of funds. Green bonds will be targeted towards refinancing of operating projects; thus they will help release capital for fresh An IDF can operate either as a trust or a company. An IDF formed as a trust is a mutual fund referred greenfield projects. as IDF-MF; whereas an IDF formed as a company is a NBFC, referred as IDF-NBFC. An IDF-MF is allowed to invest at any stage of the project lifecycle, but an IDF-NBFC can use funds only to re- Bonds may be listed on specialized exchanges including AIM, London or Luxembourg to improve finance a project's debt. Once formed, IDFs can raise funds from potential investors. (See Table 4: liquidity. Characteristics of Infrastructure Debt Funds in India)

Challenges

Risks such as long term currency risk or political or regulatory risks may be difficult to cover. Bonds will require strong risk covers.86

What needs to be done?

It is important to identify anchor institutions or corporates who have a good operating asset portfolio and who may benefit from green bond issuance. There are established guidelines on ECBs. Regulatory hurdles are expected to be less, although this issue will be assessed in detail when a pilot issuance is being conceptualized.

In addition to above there is a need to develop a method for obtaining long term hedges for INR to USD transactions. RBI has recently announced a hedge for INR to USD at 3.5 percent per annum for attracting Foreign Currency Non Resident deposits.87

6.3.2 Use of Infrastructure Debt Fund for Renewable Energy

NBFCs and commercial banks are the main source of debt in India. However, they typically face difficulties in providing long-term funding for infrastructure projects due to an asset-liability mismatch. In addition to this, banks also have to deal with internally set sector limits.

86 In this context, an interesting application for using green bonds could be a RE utility for SEZs where the PPAs with SEZ residents are established in USD (or USD linked). 87 Available at http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8388&Mode=0, last accessed on September 13, 2013

64 PACE-D Technical Assistance Program Financing Renewable Energy in India 65 How can Green Bonds help? IDFs allow tapping of long-term, low-cost debt from insurance, pension funds, and other long-term investors (both domestic and foreign), to refinance bank debt for infrastructure projects. By Benefits refinancing, the IDFs can release a large capacity of banks to finance greenfield projects.

Challenges

Risks such as long term currency risk or political or regulatory risks may be difficult to cover. Bonds will require strong risk covers.86

What needs to be done?

6.3.2 Use of Infrastructure Debt Fund for Renewable Energy

64 PACE-D Technical Assistance Program Financing Renewable Energy in India 65 Table 4: Characteristics of Infrastructure Debt Funds in India Characteristic IDF as trust (IDF-MF) IDF as company (IDF-NBFC)

88 89 Characteristic IDF as trust (IDF-MF) IDF as company (IDF-NBFC) Risk bearers Investors in bonds IDF Company Regulating authority Securities and Exchange Board of India Reserve Bank of India (RBI) Return on assets Pass through to the investors directly, less - Not specified by regulator. (SEBI) the management fee - Sponsors can define sharing of Sponsor - Any domestic entity regulated by SEBI - Only NBFCs registered as returns while forming IDFs - Existing Mutual Funds can be the Infrastructure Finance Company Limit on investors Not less than 5 investors with no investor Not specified by regulator sponsors for IDFs as clarified by SEBI. (NBFC-IFCs) are eligible for investing more than 50 percent of fund; sponsoring IDF-NBFCs Minimum investment will be INR 10 million - In case of NBFC sponsor, NBFC need with INR 1 million as minimum size of the unit to • Have existed for minimum 5 years Potential investors Less risk averse offshore institutional More risk averse offshore institutional • Have net owned funds of Minimum investors investors, offshore HNIs, NRIs and INR 3 billion domestic institutional investors

Minimum fund size Firm commitment for at least INR 250 - Minimum Fund size is INR 3 billion. 90 million from strategic investors before - No firm commitments needed Structure of IDF-NBFC allotment of marketing scheme to from investors prospective investors According to RBI guidelines, only NBFCs registered as Infrastructure Finance Companies can Currency of Rupee - Rupee or sponsor an IDF-NBFC. Once formed, the IDF-NBFC can raise funds from investors in the form of denomination - Dollar both debt and equity. Investors can be domestic investors (e.g. FIs and individuals) or/and foreign investors. IDF-NBFCs can only refinance debt (up to 85 percent of existing debt) for projects which Maturity Minimum of 5 years Minimum of 5 years have been in commercial operation for more than a year. All these projects need to be guaranteed Trade of IDF bonds Issues units listed on a recognized stock Issues bonds tradable among by the project authority for the IDF-NBFC to buyout the debt (See Figure 6: Structure of IDF-NBFC). exchange and tradable among domestic domestic and foreign investors. and foreign investors IDF quality None Minimum 'A' rating from CRISIL or Figure 7: Structure of IDF-NBFC requirements equivalent ratings from FITCH, CARE and ICRA Sponsor Investors Eligible Infrastructure companies or SPVs across Public Private Partnership (PPP) (NBFC-IFC) projects/companies all infrastructure sectors, project stages projects which have a buyout D C s and project types guarantee from project authority and is a l n t p a io r it it t have completed at least one year of ib a p u u l a ib t C tr commercial operation io s n i s D Fund deployment - At least 90 percent of its assets need - 100 percent of the assets need to Buyout Guarantee to be invested in debt instruments of deployed in refinancing debt of Project Authority IDF-NBFC above stated projects/companies commercial operating projects - Up to 10 percent can be used for equity - Up to 85 percent of total debt of and other investment purposes project can be refinanced by IDF Debt<85% Debt<85% Debt<85% Debt<85%

Asset with Asset with Asset with Asset with 88 Available at http://www.sebi.gov.in/cms/sebi_data/attachdocs/1366723009386.pdf, last accessed on more than 1 more than 1 more than 1 more than 1 September 13, 2013 yr of operation yr of operation yr of operation yr of operation 89 Available at http://rbi.org.in/scripts/NotificationUser.aspx?Id=6830&Mode=0, last accessed on September 13, Debt<15% Debt<15% Debt<15% Debt<15% 203 90 Strategic investors include an Infrastructure Finance Company registered with RBI as NBFC, a Scheduled Banks/Fls Banks/Fls Banks/Fls Banks/Fls Commercial Bank, International Multilateral Financial Institution

66 PACE-D Technical Assistance Program Financing Renewable Energy in India 67 Table 4: Characteristics of Infrastructure Debt Funds in India Characteristic IDF as trust (IDF-MF) IDF as company (IDF-NBFC)

66 PACE-D Technical Assistance Program Financing Renewable Energy in India 67 Box 14: Limitation with IDF-NBFC How can IDFs help?

Under the IDF-NBFC route, a buyout guarantee from a project authority is required. In case of default Benefits by the borrower, the Project Authority is expected to repay the loan of the lender and take over the • IDFs will enable flow of funds from long term investors (both domestic and foreign) at Project. Project authorities for RE projects are most likely to be state electricity boards, which have provided PPAs for RE projects. There is no national body today, although Solar Energy Corporation of favorable terms like lower interest rates and longer tenure. Lower withholding tax is an India could play this role for solar projects under JNNSM. important incentive for international investors. • IDFs are tradable instruments and can be listed on exchanges. Liquidity can expand the Structure of IDF-MF investor base. • Refinancing of operating assets will release capital for fresh development. According to SEBI guidelines, an existing mutual fund or NBFC can sponsor an IDF-MF, which can then raise funds from domestic investors (e.g. FIs and individuals) and/or foreign investors. Challenges However, these funds need to be Rupee denominated. IDF-MF are allowed to invest in companies, The challenge is in identifying an appropriate and financially sound authority to give buy-out SPVs or projects at any stage of development in the form of debt or equity, or any other instrument; guarantee (needed in case of IDF-NBFC). but at least 90 percent of the assets need to be invested in debt instruments. (See Figure 7: Structure of IDF-MF). • State utilities can be a natural choice project authority providing the needed buyout guarantee. This will be possible for projects supplying power under FiTs or bidding mechanisms. However many state utilities do not have necessary financial strength to make Figure 8: Structure of IDF-MF the guarantee credible.

Sponsor • For JNNSM projects, the Solar Energy Corporation of India (SECI) could be the project Investors (Mutual Fund) authority.

D C s is a l n What needs to be done? t p a io r it it t ib a p u u l a ib t C tr • Identify appropriate project authorities for various PPA/ development models. io s n i s D • Explore the possibility of developing a national authority to provide the buy-out guarantee, Management Fee Fund Manager IDF-MF with MNRE. These could also be for national institutions such as IREDA, IIFCL or, for solar projects, SECI.

Debt/Equity Debt/Equity Debt/Equity Debt/Equity • Develop standard tripartite agreements and other supporting documents, using the templates already available for other infrastructure projects. Asset Asset Asset Asset • Identify potential anchor NBFC/MFs for raising IDFs. • Identify a pilot portfolio of assets for deploying the IDF.

91 IDFs for RE projects need to be developed as per the structures allowed by regulatory authorities. 6.3.3 Off-Grid Renewable Energy Fund Few IDFs have raised capital for the market from other infrastructure sectors but no IDF has been set up so far for RE. A majority of off-grid projects in India have been financed through government subsidies, grants, investments from impact investors, and in some cases, with small portions loans from FIs (between10 and 20 percent). Due to the reasons discussed in Section 5, very few investors and FIs are open to lending to off-grid projects. Thus, there is a need for a fund focused on the off-grid RE 91 SEBI and RBI are regulatory authorities for IDF-MF and IDF-NBFC respectively market in India.

68 PACE-D Technical Assistance Program Financing Renewable Energy in India 69 Box 14: Limitation with IDF-NBFC How can IDFs help?

Sponsor • For JNNSM projects, the Solar Energy Corporation of India (SECI) could be the project Investors (Mutual Fund) authority.

68 PACE-D Technical Assistance Program Financing Renewable Energy in India 69 Features of Off-Grid Funds Challenges India has enough experience and adequate policy regimes for establishing equity funds. No The fund will have the following features: significant challenges are anticipated except finding the right anchor for the fund. • The objective of the fund will be to invest in off-grid rural projects as well as onsite energy What needs to be done? projects for C&I segments. The fund would invest in projects which generate RE, enhance EE, and support activities which generate demand for rural electricity. • Identify an appropriate anchor organization. • The fund will raise capital from HNIs, NRIs, CSR budgets, and impact investors. • Design the fund objective and size, investing themes, target investors, fund management • It will co-invest with RESCOs using a combination of equity and mezzanine equity. and governance structure, investment instruments, and exit options. • It will also support pre-finance activities to develop scalable programs for off-grid RE • Pre-market the fund to a few large CSR investors, endowment funds, and DFIs to improve implementation. Development expenses will be recovered when projects or programs are the fund concept and assess the investment potential. financed. 6.3.4 Risk Insurance Schemes • The fund will help the investee programs raise other types of capital as well as channel As discussed in section 3 of the report, RE projects face various risks including those associated government subsidies. with fuel, technology, policy, and off-takers. The combination of one or more of these risks leads to • The fund can be clubbed with a tax-efficient structure (as proposed in section 6.1.1), which default risk on the loans provided to RE projects. While ADB and the World Bank have partial risk will make it even more attractive for investors. guarantee schemes available for Indian RE projects, these have either not been used or have not been implemented effectively. Also, RE focused bodies like IREDA, which have substantial exposure The Fund will be structured like a private equity fund. However it may have a government or PSU to the sector, do not have any risk guarantee programmes. As such, there is a need to work with anchor to attract CSR funds and to catalyse the right kind of policy environment for off-grid RE. insurers to develop products that mitigate some of these risks. (See Figure 9: Insurable Risks for RE Projects) The Sustainable Development Fund of Hong Kong (USD 100 million) and the New Zealand Partnerships for International Development (USD 80 million) are funds with similar approaches. Figure 9: Insurable Risks for RE Projects How can Off-Grid Funds help? • Cover for risk arising from unjust changes in regulatory policy, pre- Benefits • Contractor all risk mature termination of contracts, cover Advanced loss non - fulfillment of obligations • The fund will support competent RESCOs to scale up. Investment by the fund may be of profit cover Design considered a validation of the RESCOs' capabilities, and therefore the RESCOs may be able liability insurance etc Political risks, • Cover for replacement to leverage debt sources as well. regulatory of costly failed costly Machine Project risks components of a machine Break • The Fund will focus on improving the scalability of off-grid programs by catalyzing • Serial loss cover implementation risks down risks appropriate policy at the state-level, helping aggregation of demand, being the channel for • Performance guarantee not met government support/incentives, and supporting RESCOs in arranging project finance. • Supplier doesn’t • Cover for credit risk, interest rate risk, survive Technology Finance risks • Although new regulations from the Ministry of Corporate Affairs provide a clear push for • Coverage against risks currency risk etc. CSR activities, many corporates do not have effective investment vehicles for channeling revenue and other losses CSR resources. The proposed off-grid fund could be such a vehicle. • Cover for • NRIs and HNIs would also invest in this fund driven by the appeal for building rural India. extraordinary event • Cover for or circumstance Such investments could be supported by special capital protection measures and tax revenue loss Resource Insurable Force Majeure beyond the control if resource benefits to NRIs and HNIs. risks event risks of the parties like falls below a risks war, strike, natural floor • The fund may also support the development of effective business models and standards for calamities etc scaling up off-grid RE capacity.

70 PACE-D Technical Assistance Program Financing Renewable Energy in India 71 Features of Off-Grid Funds Challenges India has enough experience and adequate policy regimes for establishing equity funds. No The fund will have the following features: significant challenges are anticipated except finding the right anchor for the fund. • The objective of the fund will be to invest in off-grid rural projects as well as onsite energy What needs to be done? projects for C&I segments. The fund would invest in projects which generate RE, enhance EE, and support activities which generate demand for rural electricity. • Identify an appropriate anchor organization. • The fund will raise capital from HNIs, NRIs, CSR budgets, and impact investors. • Design the fund objective and size, investing themes, target investors, fund management • It will co-invest with RESCOs using a combination of equity and mezzanine equity. and governance structure, investment instruments, and exit options. • It will also support pre-finance activities to develop scalable programs for off-grid RE • Pre-market the fund to a few large CSR investors, endowment funds, and DFIs to improve implementation. Development expenses will be recovered when projects or programs are the fund concept and assess the investment potential. financed. 6.3.4 Risk Insurance Schemes • The fund will help the investee programs raise other types of capital as well as channel As discussed in section 3 of the report, RE projects face various risks including those associated government subsidies. with fuel, technology, policy, and off-takers. The combination of one or more of these risks leads to • The fund can be clubbed with a tax-efficient structure (as proposed in section 6.1.1), which default risk on the loans provided to RE projects. While ADB and the World Bank have partial risk will make it even more attractive for investors. guarantee schemes available for Indian RE projects, these have either not been used or have not been implemented effectively. Also, RE focused bodies like IREDA, which have substantial exposure The Fund will be structured like a private equity fund. However it may have a government or PSU to the sector, do not have any risk guarantee programmes. As such, there is a need to work with anchor to attract CSR funds and to catalyse the right kind of policy environment for off-grid RE. insurers to develop products that mitigate some of these risks. (See Figure 9: Insurable Risks for RE Projects) The Sustainable Development Fund of Hong Kong (USD 100 million) and the New Zealand Partnerships for International Development (USD 80 million) are funds with similar approaches. Figure 9: Insurable Risks for RE Projects How can Off-Grid Funds help? • Cover for risk arising from unjust changes in regulatory policy, pre- Benefits • Contractor all risk mature termination of contracts, cover Advanced loss non - fulfillment of obligations • The fund will support competent RESCOs to scale up. Investment by the fund may be of profit cover Design considered a validation of the RESCOs' capabilities, and therefore the RESCOs may be able liability insurance etc Political risks, • Cover for replacement to leverage debt sources as well. regulatory of costly failed costly Machine Project risks components of a machine Break • The Fund will focus on improving the scalability of off-grid programs by catalyzing • Serial loss cover implementation risks down risks appropriate policy at the state-level, helping aggregation of demand, being the channel for • Performance guarantee not met government support/incentives, and supporting RESCOs in arranging project finance. • Supplier doesn’t • Cover for credit risk, interest rate risk, survive Technology Finance risks • Although new regulations from the Ministry of Corporate Affairs provide a clear push for • Coverage against risks currency risk etc. CSR activities, many corporates do not have effective investment vehicles for channeling revenue and other losses CSR resources. The proposed off-grid fund could be such a vehicle. • Cover for • NRIs and HNIs would also invest in this fund driven by the appeal for building rural India. extraordinary event • Cover for or circumstance Such investments could be supported by special capital protection measures and tax revenue loss Resource Insurable Force Majeure beyond the control if resource benefits to NRIs and HNIs. risks event risks of the parties like falls below a risks war, strike, natural floor • The fund may also support the development of effective business models and standards for calamities etc scaling up off-grid RE capacity.

70 PACE-D Technical Assistance Program Financing Renewable Energy in India 71 Acronyms Risk Insurance Available in India

The risks depicted in yellow in Figure 9 above are not yet Acronyms Definition well covered in the Indian market, although they are used in most developed markets such as the U.S., EU, and Japan ADB Asian Development Bank and provide significant comfort to investors and lenders. AFD Agence Francaise de Developpement

It is important to work with insurers, FIs, IREDA, and AIM Alternative Investment Market multilateral agencies like the World Bank and ADB to APPC average pool purchase cost develop risk insurance instruments for RE projects which are acceptable to lenders and developers in India. BOMT build operate maintain and transfer C&I commercial and industrial How Can Risk Insurance Help? CBGA Centre for Budget and Governance Accountability Benefits CERC Central Electricity Regulatory Commission • Reduces risks for a specific project, although at a cost (cost of insurance) to address the issue that RE projects are capital intensive and can have significant components of resource, CFA capital financial assistance technology, political and financial risks, this raises the cost of finance for projects, reduces CSP concentrated solar power flow of finance, and effectively excludes bulk investors as they are risk averse. CSR corporate social responsibility • Insurance covers require careful design of a project, use of high quality resources and high quality vendors. Therefore availability of risk covers signals high quality of a project and DDG decentralized distribution generation expedites lending and investing. DFI development finance institutions • Proper risk covers can help projects migrate from one stage of financing (e.g. construction DEG Deutsche Investitions-und Entwicklungsgesellschaft finance) to the other (re-finance through long term bonds). Any large scale investment program would therefore benefit from a well-designed insurance product. DISCOM distribution company Challenges DPR detailed project report ECB external commercial borrowing One of the challenges in using risk insurance for RE projects in India is that insurance companies perceive the Indian RE market to be small and not worth their attention. However, in a few ECERT energy efficiency certificates preliminary discussions, national insurance players92 have shown interest in developing these EE energy efficiency insurance products for the RE market. EIB European Investment Bank What needs to be done? EXIM Bank Export Import Bank

93 Global insurance companies have experience in insuring RE projects and some of them seem FDI foreign direct investment interested to pilot insurance products for RE in India. There should be a dialogue between global and Indian insurance companies, in order to determine whether and how a few pilot insurance products FI financial institution can be developed. FiT feed-in tariff FY financial year (April to March) 92 Such as New India Assurance 93 For example, Hannover RE and Munich RE FYP Five Year Plan

72 PACE-D Technical Assistance Program Financing Renewable Energy in India 73 Acronyms Risk Insurance Available in India

72 PACE-D Technical Assistance Program Financing Renewable Energy in India 73 Acronyms Definition Acronyms Definition

GBI generation based incentive kW kilowatt GHI global horizontal irradiance kWe kilowatt equivalent kWh kilowatt hour GIEK Garanti-instituttet for eksportkreditt kWp kilowatt peak GOI Government of India kWth kilowatt thermal GW gigawatt LBNL Lawrence Berkeley National Laboratory GWh gigawatt hour LIBOR London Interbank Offered Rate HNI high-net-worth individual LIC Life Insurance Corporation ICRA Limited Formerly Investment Information and Credit Rating Agency of L&T Infra L&T Infrastructure Finance India Limited m meter IDA International Development Agency MAT Minimum Alternate Tax IDF infrastructure debt fund MFI micro finance institution IEGC Indian Electricity Grid Code MLP master limited partnership MMT million metric ton IFC International Finance Corporation MNRE Ministry of New and Renewable Energy IIFCL India Infrastructure Finance Company Ltd. MoEF Ministry of Environment and Forests IISc Indian Institute of Science, Bangalore MoF Ministry of Finance IMG Inter-Ministerial Group MoP Ministry of Power INR Indian Rupee MW megawatt IPO initial public offering MWh megawatt hour IPP independent power producer NABARD National Bank for Agricultural and Rural Development IREDA Indian Renewable Energy Development Agency NAPCC National Action Plan on Climate Change NBFC Non-Banking Finance Company IT income tax NORD/LB NorddeutscheLandesbank Norddeutsche Landesbank J&K Jammu and Kashmir NRI Non-Resident Indian JBIC Japan Bank for International Cooperation O&M operations and maintenance JICA Japan International Corporation Agency OEM original equipment manufacturer JNNSM Jawaharlal Nehru National Solar Mission OPIC Overseas Private Investment Corporation KfW Kreditanstalt für Wiederaufbau PFC Power Finance Corporation km kilometer PLF plant load factor PPA power purchase agreement kV kilovolt PTC Power Trading Corporation

74 PACE-D Technical Assistance Program Financing Renewable Energy in India 75 Acronyms Definition Acronyms Definition

74 PACE-D Technical Assistance Program Financing Renewable Energy in India 75 References Acronyms Definition PV photovoltaic RBI Reserve Bank of India No. Reference REIT Real Estate Investment Trust 1 GOI. 2003. Government of India, The Electricity Act, Ministry of Power, New Delhi. RE renewable energy 2 GOI. 2010a. Government of India, Central Electricity RegulatoryCommission (Terms and REC Renewable Energy Certificate Conditions for recognition and issuance ofRenewable Energy Certificate for Renewable Energy Generation)Regulations, 2010, Central Electricity Regulatory Commission, New RET renewable energy technology Delhi. RESCO Renewable Energy Service Company 3 GOI. 2010b. Government of India, Central Electricity Regulatory Commission (Indian RGGVY Rajiv Gandhi Grameen Vidyutikaran Yojana Electricity Grid Code) Regulations, 2010, Ministry of Power, New Delhi. RMM REC Market Maker 4 GOI. 2011a. Government of India, The National Electricity Policy, Ministry of Power, New RPO renewable purchase obligation Delhi.

RPSSGP Rooftop PV and Small Solar Power Generation Programme 5 GOI. 2011b. Government of India, Consolidated FDI Policy, Ministry of Commerce and RVE Remote Village Electrification Industry, New Delhi. SDA State Designated Agency 6 GOI. 2012. Government of India, Jawaharlal Nehru National Solar Mission Phase II – SEB State Electricity Board Policy Document, Ministry of New and Renewable Energy, New Delhi. SEBI Securities and Exchange Board of India 7 IREDA. 2012. Indian Renewable Energy Development Agency Ltd, Annual Report 2011- 12, New Delhi. SERC State Electricity Regulatory Commission SGD Singapore Dollar 8 LBNL. 2011. Lawrence Berkeley National Laboratory, Reassessing Wind Potential Estimates for India, California. SHP small hydro power 9 Mytrah. 2012. Mytrah Energy Ltd, Annual Report and Accounts 2012, London. SNA state nodal agency SPV special purpose vehicle 10 CBI. 2012. Climate Bonds Initiative, Bonds and Climate Change – The State of The Market in 2012, Commissioned by HSBC, London. sq km square kilometer 11 NAPCC. 2008. Government of India, Prime Minister's Council on Climate Change, sq m square meter National Action Plan on Climate Change, New Delhi. U.S. United States of America 12 PFC. 2012. Power Finance Corporation Ltd, Annual Report 2011-12, New Delhi. USD United States Dollar 13 U.S. EXIM. 2012. Export – Import Bank of the United States, Annual Report 2012, V volt Washington, D.C. W watt 14 Ramachandra, et al. 2011. T.V. Ramachandra, RishabhJain, and GauthamKrishnadasa, Wp watt peak Hotspots of Solar Potential in India, Renewable and Sustainable Energy Reviews, April WBG World Bank Group 2011. WRA wind resource assessment 15 Winrock. 2012. Winrock International India, Access to Clean Energy – A Glimpse of Off- Grid Projects in India, Prepared for Ministry of New and Renewable Energy, New Delhi.

76 PACE-D Technical Assistance Program Financing Renewable Energy in India 77 References Acronyms Definition PV photovoltaic RBI Reserve Bank of India No. Reference REIT Real Estate Investment Trust 1 GOI. 2003. Government of India, The Electricity Act, Ministry of Power, New Delhi. RE renewable energy 2 GOI. 2010a. Government of India, Central Electricity RegulatoryCommission (Terms and REC Renewable Energy Certificate Conditions for recognition and issuance ofRenewable Energy Certificate for Renewable Energy Generation)Regulations, 2010, Central Electricity Regulatory Commission, New RET renewable energy technology Delhi. RESCO Renewable Energy Service Company 3 GOI. 2010b. Government of India, Central Electricity Regulatory Commission (Indian RGGVY Rajiv Gandhi Grameen Vidyutikaran Yojana Electricity Grid Code) Regulations, 2010, Ministry of Power, New Delhi. RMM REC Market Maker 4 GOI. 2011a. Government of India, The National Electricity Policy, Ministry of Power, New RPO renewable purchase obligation Delhi.

76 PACE-D Technical Assistance Program Financing Renewable Energy in India 77 Annex

Annex A : Summary of Solar Reverse Bidding Programs

Program Year Capacity Wining tariff in Benchmark tariff allocated INR/kWh in INR/kWh (in MW) (US cents/kWh) (US cents/kWh)

Jawaharlal National Solar Mission 2010 150 10.95 - 12.24 17.91 (JNNSM), Phase I, Batch I (17.5 – 19.6) (28.6)

Jawaharlal National Solar Mission 2011 350 7.49 - 9.44 15.39 (JNNSM), Phase I, Batch II (12.0 – 15.1) (24.6)

Madhya Pradesh Power Trading 2012 200 7.90 - 8.05 15.35 Company (12.6 – 12.9) (24.5)

Grid Corporation of Orissa 2012 25 7.28 * (11.6) Andhra Pradesh Transmission 2013 416 so far and 6.49 * Corporation ongoing (10.4)

Tamil Nadu Generation & Distribution 2013 690 6.48 * Corporation (10.4) (5 percent annual escalation for 10 years)

Rajasthan Renewable Energy 2013 75 6.45 8.42 Corporation Ltd. (10.3) (13.5)

Karnataka Renewable Energy 2013 130 5.51 – 8.05 14.5 Development Ltd. (8.8 – 12.9) (23.2)

Note: * No benchmark tariff was provided, the lowest tariff in the bidding won

Financing Renewable Energy in India 79 Annex