Climate Financing in India: Challenges and Opportunities

Recently two major partnerships have been seen between India and two leaders of western economy, the US and UK. These partnerships were in the news due to their focus being the ongoing crisis of climate change, and financing in the sector. However, there is more to the subject than what meets the eye. 

Climate financing in the simplest terms is the investment that is made towards reducing emissions and protection of the environment. It is a subset of the more encompassing ‘Green Finance’, which is geared towards promotion of sustainable development. India is currently facing a shortage in both. As per the Climate Policy Initiative (CPI), India will require approximately Rs 11 Lakh crore or USD 170 Billion per year for climate action and to achieve its 2030 targets! Currently India is investing $810 Billion per year in Renewable Energy since 2018!

There are many restrictions in India that makes climate financing a less than lucrative option for investors. In addition, there is a perception that climate financing, and climate change, function in silos to economic development and has no impact on it. This perception has further dampened the progress that we could have seen in the sector. Adding to it are the internal factors like weak financials of DISCOMs, constant re-tendering of projects, flip flop in policies, federal structure of electricity and now the slowdown due to the pandemic and lockdown has not helped either. 

Let us look at the data pertaining to Green financing in India which highlights these challenges. The research published by CPI in September 2020 brings some interesting points to the forefront. 

Foreign Direct Investment accounts for around 5% of the total investments, which is one of the lowest, only tied with investments by corporates. Overall, only 15% of the total investments were international in origin. A significant portion of the burden of carbon emissions and other environmental degradation is to be borne by developing countries but only 25% of the funds raised by developed countries are being invested in developing countries. Most of India’s green finance comes from commercial banks in India, and for us to realise our climate goals, we need far more foreign investment and participation from domestic investors.

At this stage, how about we take one step back and look at the economic implications and the impact on economic growth that climate change will have, putting an urgency to climate financing.

Global consultancy firm McKinsey in its report looking at the correlation between climate change and economic development, shared that by 2030, India would be putting between 2.5% and 4.5% of its GDP at risk due to the lost average daylight hours. It is very evident that the downside of under investing in the fight against climate change hurts India’s future economic development. As an industry, renewable energy has been leading the green initiative in India from the forefront. However, the industry is vastly underappreciated and requires financing to grow by 17 times from the current levels. The key question is how can we quickly mobilize the resources required to meet our future financing needs?

The current focus of financing in the Indian renewable energy sector is lending through commercial banks, which may not be best suited for this role as they have little expertise in renewable energy. Moreover, many of them have been saddled with legacy lending to the thermal sector with many NPAs. Hence, there is inherent reluctance to lend to the sector. There is a great need for specialized institutions, such as IREDA, that focus exclusively on financing renewable energy projects. IREDA’s loan book of $3.5 Billion USD is too small to meet the financing needs of the sector and there is a great need for increasing the number and size of such institutions. Moreover, with IREDA’s gross NPA’s of 10% and top 20 borrowers accounting for over 35% of its loan book, it shows a relatively high degree of concentration risk. This degree of concentration risk is also noticeable in the lending by commercial banks. For instance, facilities extended by Asian Development Bank and other multilateral institutions for financing of the roof-top segment were primary driven by SBI and PNB in India. Both these banks concentrated the lending on top 20 developers in India, thereby ensuring a high degree of concentration risk. Even on the utility scale, the same practice has been followed. 

The concentration of the loan portfolio in 15-20 developers creates two major issues. One, it provides for a high degree of concentration risk. Second, the development of the Renewable sector is left in the hand of these developers. Their pace of growth invariably decides the growth of the sector and their financial performance invariably decides the quality of the loan book.

Hence, there is a need to diversify the loan book of the banks and multilateral agencies from the top developers. We need to provide avenues for the HNIs, retail investors to invest the sector and gets access to finance. In short, there is an urgent requirement for democratisation of renewable energy in the country. For example, when an industry goes for solar roof-top loan in India, they may be asked to provide their land, their dogs, and even their clothes as collateral. This makes it obviously unattractive for them to invest into such projects. The lending needs to focus on addressing such segment, or even smaller developers.

What about the savings of middle class? Funds in societies? Fund that are completely not utilised? We need to get them to invest in rooftop solar.
Moreover, we need a more robust and holistic regulatory framework and significant push from the Government. In the latter half of 2020, RBI revised it Priority Sector Lending (PSL) norms to double the limit to 30 crore. However, if we look at Bank portfolios, renewable energy holds a minor portion. Smaller developers and households opting for renewable energy hold an even tinier portion of that. There is enough space for growth and increased funding provided specialized institutions for Renewable Energy financing are setup with backing from the central government and RBI. Some measures such as first loss guarantee from the central government can do wonder in boosting credit. However, it will be important to ensure the benefit is taken up only by the under-served segments such as MSME’s and households. 

Our recent collaborations with US and UK, who have both been frontrunners in the space, can assist with access to wider low-cost finance pool and development funds. Coupled with favourable domestic policies and regulations that attract domestic retail investors and foreign investors, we can turn the clock around and ensure we do not have to ponder over these challenges on climate financing in the coming years. I implore the Government to act quickly and now. The urgency of India’s need for climate financing to tackle climate change is real and the consequences too grave to ignore.
 

- Animesh Damani, Managing Partner, Artha Energy Resources