Samir Saran is the President of the Observer Research Foundation. Aparajit Pandey is the Program Director for Climate, Energy, and Resources Program at the Oberver Research Foundation.
As leaders gather in Katowice, Poland, for the Twenty-Fourth Conference of the Parties (COP24) to the United Nations Framework Convention on Climate Change, the possibility that India can shift to a new low-carbon growth model is a critical test for a global pact on climate change mitigation. India will be one of the first countries to transition from low- to high-income economy in a fossil fuel–constrained world.
While American leadership reneges on its climate finance commitments towards the global community, India is taking a lead to develop its economy largely through its own political and financial arrangements. Done correctly, the method and mechanics of India’s low-carbon transition can provide a replicable template for energy development across the world—especially for mitigating carbon emissions, ensuring affordable energy access for all, and eradicating poverty. A study of India also provides assessments and recommendations that can inform development efforts in Africa, Latin America, and Southeast Asia.
In the space of two years, India’s solar and wind energy prices have fallen dramatically, undercutting average coal prices by approximately 25 percent. At the same time, investments in clean energy projects have risen rapidly, with $42 billion flowing into Indian renewable energy projects over the past four years.
These optimistic figures, however, should not hide the fact that the lower rates charged by renewable energy power producers are predicated upon two volatile factors: the price of materials and government policies. Prices of renewable energy components are vulnerable to shifts in trade policy, currency depreciation, or changes in supply and demand. Moreover, with renewable power prices dropping, both central and state governments are reassessing the need for the limited incentives and subsidies they provide. In India, the resulting clean energy sector optimism over the past few years has skirted over some serious fissures in the foundations of the architecture.
Firstly, India’s public power distribution companies (DISCOMS) remain a gordian knot that the government has not been able to untangle. The issues with DISCOMS remain related to three distinct factors: poor pricing models due to political interests, weak corporate governance, and ailing infrastructure. Any measure to reform the sector needs to account for all three factors.
Secondly, India’s energy sector suffers from a lack of developed local financial markets. Debt-financing options for renewable energy projects remain limited within India because the shorter terms of saving instruments inhibit long-term domestic bank loans. Under normal circumstances, this asset and liability mismatch can be bypassed through alternative debt instruments. Use of financial vehicles such as bonds or infrastructure investment funds, however, remains limited in Indian and other emerging markets. The loans that have been given out to the clean energy sector have largely been driven by short-term macroeconomic factors such as excess capital liquidity (a byproduct of India’s 2016 demonetization reform). As the Indian banking sector hovers on the precipice of a crisis, it is likely that domestic debt financing for these projects will quickly dry up.
Finally, the risk premium that international commercial banks charge for operating in emerging economies such as India remains an unsurpassable barrier. ReNew Power, India’s largest renewable energy company, raised a $450 million bond issuance in 2017. But the bond was several levels below what was considered an investment grade rating, despite ReNew’s excellent business fundamentals and backing from Goldman Sachs, the Abu Dhabi Investment Authority, and the Green Environment Fund. Since the issuance of the bond, the firm has grown exponentially, cementing its place as one of India’s premier energy producers—demonstrating that projects and companies could be evaluated more independently of sovereign ratings.
We recommend that India reform power grids by implementing hybrid public-private systems. The Indian state of Gujarat is the exception to the country’s DISCOM issues, with all four of the state’s utilities currently showing profits. Gujarat’s path could be a model for other parts of the developing world.
On financing, direct economic interventions designed to bolster debt financing are not always viable. To increase the availability of debt financing for clean energy projects in emerging markets, policymakers can encourage the creation of alternative debt vehicles. “Green” asset backed securities are one such alternative. Securitized debt has been a largely overlooked financial instrument outside of the developed world, but recent reforms have shown the potential of the asset class in emerging markets. By compiling renewable energy assets that come from different companies and geographies at various points in their operational lifecycles, banks and other financial institutions can dilute many of the risks associated with individual renewable energy projects. To further mitigate risk through diversification and bolster the credit rating of a securitized instrument, the financial creator of the asset can also add a tranche of non-green assets. The proceeds from selling the security can then be used to finance new projects, which can in turn be securitized themselves, creating a virtuous cycle.
Another alternative to traditional debt could be developed through the creation of “green” investment banks (GIBs). GIBs are government-funded entities that “crowd in” private investment in low-carbon assets and operate like a normal investment bank, albeit with a sectoral bias. They can provide debt for projects with existing capital reserves and raise funds through the issuance of bonds and creation of asset-backed securities. They can also invest as equity partners, developing projects and conducting due diligence, if needed. The value of GIBs comes from their flexibility and ability to adapt to market conditions and trends. Moreover, GIBs have sectoral experts whose skillsets allow them to understand public- and private-sector dynamics and deal with a variety of transactions.
Finally, Basel IV, the proposed reforms for the global banking regulatory framework, should include climate change in its assessment criteria—either by measuring the exposure of a bank’s portfolio to climate change–related damage or by implementing a green factor on the weighting of risk for renewable energy projects.
The significance of India’s development choices should not be underestimated. If the success of the Millennium Development Goals was predicated on China’s economic rise, India’s capability to replicate the same in a carbon-scarce world will determine the fate of the UN Sustainable Development Goals.
This blog is excerpted from the Council of Councils Global Governance Working paper, “India and the World: Fueling a New Low-Carbon Growth Model.” Read the full paper here.