By Arunabha Ghosh & Nandini Harihar
There are two fuels for any economy: energy and finance. The energy transition that India has committed to won’t be possible without commensurate flows of capital at unprecedented scale and pace. Changes will be needed in the financial ecosystem, in how projects are rated, how green finance is certified, and in the policy framework to make investments in new energy sectors attractive. In the process, India could aim to become a hub of sustainable finance for emerging economies.
The scale of investment needed is mind-boggling. Within this decade, at least $221 billion will be needed as investment in new renewable energy capacity. The electric mobility transition (102 million EVs by 2030) offers another investment opportunity, of $206 billion. Converting every million tonnes of hydrogen to green hydrogen will need $0-40 billion (numbers vary due to falling costs). This translates to another $168-224 billion to convert the current hydrogen demand in India. In addition, other clean energy investments will include grid upgradation, battery storage, etc.
It should be sobering to note that the exposure of banks and NBFCs to the power sector is only $160 billion. The energy transition will, therefore, need volumes of capital that are many multiples of how much the financial system has been able to deliver thus far. En route to net-zero by 2070, clean power, decarbonised transport and green hydrogen for industrial energy will need investments of $10.1 trillion (in 2020 prices).
The current investment landscape, however, paints a different picture. In 2020, India received only 2% of the overall renewable energy capacity investment, as opposed to China, the EU and US accounting for 27.5%, 22.9% and 16.2%, respectively. Due to the COVID-19 pandemic, RE investment in 2020 was less than $10 billion. Globally, the picture was not much different. Between January 2020 to April 2021, recovery packages allocated $53.1 billion as direct support to renewable energy. But this was nearly six times lower than that provided for fossil fuels.
The latest analysis from CEEW’s Centre for Energy Finance and the International Energy Agency finds that India’s solar and wind tariffs have dropped by over 80% and 60%, respectively, since 2014, down to Rs 1.99/kWh ($0.026/kWh) for solar PV by December 2020. Aggressive bidding by central public sector undertakings and international power producers resulted in further squeeze on equity returns: Equity IRR expectations fell to 13.3% in H1 of 2021 compared to 14.9% in 2020. These expectations are still nearly twice that of those in the US. Opportunities for scale still abound. Acquisitions of RE companies soared in 2021, amounting to $6 billion.
But international finance—investment, concessional loans, or grants—for climate action falls short. During COP-26, the Glasgow Financial Alliance for Net Zero, a group of private sector financial players with assets totaling $130 trillion, signed a pledge to decarbonise their portfolios by 2050. But no near-term plans, deadlines or commitments were announced. Developing countries asked for $1.3 trillion of investment but nothing concrete was promised. While the UK COP Presidency’s Climate Finance Delivery Plan suggested that $100 billion would be delivered by 2023, even this was not explicitly mentioned in COP outcomes.
India and other emerging markets are caught in a chicken-and-egg situation. International investors keep insisting that there are not enough investable projects. Yet, raising ambition does not translate to automatic deal flows. Four interventions are needed to catalyse the market for clean investments.
First, debt markets must deepen. India faces a triple challenge of not sufficient credit flow in the market, poorly rated projects and high costs of credit enhanced bonds. The answer is subsidised credit enhancement, serving as a first-loss guarantee in case bond issuers are unable to service the coupon or principal payment. CEEW-CEF calculates that a subsidy of Rs 4,543 crore ($649 million), spread over a defined period of five years, could mobilise debt capital of up to Rs 75,984 crore.
Secondly, a green taxonomy would create greater awareness about green sectors and reduce greenwashing. Equity investors are interested in maturity of markets, such that they can underwrite the alpha from investments. Currently, investors are showing interest in “ESG-compliant” businesses, but in many cases these projects do not turn out to be genuine. A revised taxonomy (beyond renewables) should also offer a better framework for equity investors to measure impact in other sectors, such as agriculture, construction and mobility.
Thirdly, transition finance is needed in emerging markets to accelerate a phase down of fossil fuel infrastructure. Except China, fossil fuel demand for electricity has already peaked or plateaued in emerging markets accounting for 63% of total demand. So, while most of the growth (88%) in electricity demand until 2040 will come from emerging markets, they still have to transition away from existing fossil fuel capacity. This needs innovative financing to write down equity, pay off debt and create a viable package for workers.
At COP-26 France, Germany, the UK and the US committed to a $8.5-billion deal to help South Africa decommission 34 GW of coal-fired power capacity by 2030. Negotiating such arrangements country by country could take forever. Instead, transition bonds could be raised as a sub-category of a green taxonomy, to help utilities shift their portfolios towards more efficient thermal power or help thermal asset owners decommission older, inefficient plants.
Fourthly, a de-risking facility is needed for emerging markets. The largest share of the levelised cost of electricity (LCOE) from clean energy projects in developing countries is the cost of finance. India could host a Global Clean Investment Risk Mitigation Mechanism (GCI-RMM). Working on the principle of risk pooling across projects and countries, it could help to ease the flow of capital and access to non-project risk management tools—reduce transaction costs in emerging markets.
For the seven-odd quarters until when India hosts the G-20 summit in 2023, a roadmap could be laid down to showcase these innovations. These could include a fit-for-purpose green taxonomy for India, a subsidised credit enhancement product, issuance of transition bonds, a warehousing facility for rooftop solar projects (to offer a larger portfolio to investors), pooled funds for a pilot project on green steel, and the political signal to house a global risk mitigation mechanism.
Once these innovations see the light of day, India could start routing deals for other developing countries through its financial institutions. Rather than just focus on definitions of climate finance at annual negotiations, India’s regulators and market participants can begin work to build a green finance architecture—for India and the emerging world.
Respectively, CEO, and research analyst, Council on Energy, Environment and Water