INTRODUCTION

Global investments in renewable energy are increasing at an exponential rate. At the start of the century, between 2000 and 2009, this sector drew total investments of US$ 2.6 trillion.1
It continued to grow in the subsequent years and peaked at US$ 351 billion in 2017, before declining to US$ 322 billion in 2018 due to falling cost of renewable energy which meant
more capacity addition per unit of investment. Cost reductions as well as improved technology and systems have made this sector competitive as compared to conventional fossil fuel. The cost of solar energy has dropped by 85 percent over the last decade.2 There is increased
policy support from the government as well as from members of the industry that are increasingly adopting sustainability parameters as part of their mandate. Solar energy is an abundant resource and can play a significant role in meeting the climate goals of keeping global temperature below 2 degrees. Successfully meeting the goals set by the Paris Agreement would lead to the share of renewables in total renewable use to increase to 85 percent in 2050 as compared to only 20 percent in 2016. Further, end-use products such as solar pumps can power livelihoods in developing countries.

THE RATIONALE FOR A SOLAR FINANCE CORPORATION

Between 2000 and 2017, there was a 15-fold increase in investment flows to developing countries that have focused on clean and renewable energy.3 However, the majority of total investments originated from, and flowed to Organisation for Economic Cooperation and Development (OECD) countries. Between 2013-2018, 85 percent of the investments went to developed countries, whereas only about 15 percent was invested in developing and emerging economies.4 Of this, South Asia attracted about 4 percent of the total, averaging US$ 16 billion between 2013 to 2018.

Renewable energy is financed largely by private financial institutions, which account for 86 percent of the financing provided in the same 2013-2018 period. Private financial institutions are profit-driven and tend to concentrate on mature technologies and regions to capture attractive returns. A Solar Finance Corporation can help in financing investments in new technologies and underdeveloped markets.

Developing and emerging countries need access to financing at concessional rates (relative to typical commercial rates) to allow them to make investment choices that will replace brown energy sources with greener ones. It is noteworthy that 95 percent of financing for renewable energy between 2013 and 2018 was provided at commercial rates, and only 4 percent were financed at concessional rates. International public finance plays a significant role in investing in riskier countries, but even in this category only about 12 percent of the total went to the least developed countries.

Although the majority of institutional investors are concentrated in developed countries, the growth in emerging economies is picking up and there are sizable institutional investors in these markets as well. Insurance markets in Africa, Latin America and Asia-Pacific accounted for more than 50 percent of the growth between 2014 and 2017.7 Given that capital flows originate and invest in domestic markets, this growing pool of institutional investors in emerging countries can be a key source of financing that can be used to fund green and long-term investments. Finally, development finance institutions (DFI) have had limited growth in
recent years as their investments have plateaued. This is in part due to the shrinking fiscal space in developed countries, as well as higher risk perception in emerging countries.8 Thus, while there is growing need and demand in emerging countries, existing DFIs are not meeting them.

BARRIERS TO SOLAR INVESTMENTS IN DEVELOPING COUNTRIES

Solar energy requires large and long-term financing that is difficult to obtain especially for developing countries. Debt financing is generally available only for periods of five to six years. Banks are also wary of lending in this sector as they lack the experience with renewable technologies that would allow them to assess the risks involved. This results in high costs of financing for renewable sector projects. The cost of borrowing can be significantly higher than in developing countries. Moreover, renewable energy projects require significant equity finance. This helps them cover the development activities of the project and represents the risk capital invested in a project. Equity investments imply that the investor has an ownership stake in the project. Different equity investors are involved at different stages—for example, venture capital firms are focused on the early stages of the project, and corporate or strategic investors cover the latter stages, including just before an initial public offering.

The small scale of the projects in developing countries is another factor that creates issues when accessing private financing. The initial cost of such projects can be a significant obstacle in its widespread deployment, leaving a limited number of financing institutions that are willing to invest in this market segment. Off-grid solar projects are also an important local power generation for rural areas that are not connected to the grid due to high costs. Such projects are crucial to ensure affordable access to energy. The risks for such decentralised systems are much higher due to the location (for example rural areas for off-grid projects) as well as the target group (lowincome populations). Currency risk is also higher in developing countries, especially for currencies that are not traded frequently. There is a need for new innovative financing structures that help provide a risk-adjusted return that is attractive
to investors by covering early-stage risks in such projects. This is where multilateral financing institutions such as an SFC can be crucial in helping reduce risk for the private sector and help develop new markets for renewable energy.

PROPOSED MANDATE FOR A SOLAR FINANCE CORPORATION

T he challenges associated with investments in renewable projects include currency risks, high up-front costs, and under-developed markets in developing countries. The rationale for concessional equity investments is to fill the gap in underserved markets in developing countries. But due to the new and risky nature of such investments, the returns may be lower. On the other hand, equity investments can also allow the bank to earn high rates of interest through investments in proven technologies and established markets. Thus, a balanced approach to equity investments can help fulfil the mandate of maximising developmental impact while earning a commercial rate of return. Equity investments also have a higher demonstration effect as it encourages further investments by other players. The Solar Finance Corporation that is being proposed in this report will have to develop a balanced portfolio with some speculative projects with steep returns that will offset more traditional projects with well-defined returns. The International Finance Corporation’s (IFC) proven returns shows that it is
possible to achieve both these objectives: the IFC has obtained 15 percent returns over the last 20 years in markets where it was a first-time investor.9 The positive returns can then be used to provide concessional loan products to LDCs and developing countries.

Investing in established funds can also be useful to enter a market where the SFC has little experience or presence and it can then use this experience to invest more directly in the future. A study highlights that when investing in established funds, it is important to understand the investing strategy being followed by these funds.10 This is especially important when the objective is to support new and risky technologies. Thus, the SFC’s investment approach should consider these historical biases or directions when selecting financial instruments.

INDIA’S LEADERSHIP ROLE IN THE SOLAR ENERGY SECTOR

The SFC concept is closely linked with India’s leadership role in the solar energy sector. The International Solar Alliance (ISA) is an intergovernmental treaty-based alliance, an idea that was conceived by India in 2015. It is a coalition of solar-rich countries to promote investment in solar energy and cooperate in research and development on solar energy technologies. The concept of ISA is an effort by India to play a greater role in the global climate governance. It also reiterates India’s commitment to its climate goals. The ISA aims to mobilise more than $1,000 billion by 2030 and install 1000 GW of solar power capacity globally. ISA has signed joint financial declarations with international institutions such as the Asian Development Bank, Green Climate Fund, and Asian Infrastructure Investment Bank.11 It also plans to develop insurance for the various risks involved in solar projects by aggregating demand for finance and insurance of the member countries of the ISA. The ISA will also collaborate in research
with member countries and has announced the solar technology mission as part of its 10-point action plan.12 In 2020, ISA released the first of what they promise to be an annual ‘Ease of Doing Solar’ report that will identify countries that perform well in the solar energy sector. The report compares 80 member countries across various parameters such as macroeconomy, policy enablers, technological feasibility, power market maturity, infrastructure, financing, and energy imperatives. The report is expected to be a reference for financial investors seeking to take part in the solar sector. Thus, ISA can play an important role in closing the information gap that investors face and facilitate greater investments towards the sector.

STRUCTURE OF THE SOLAR FINANCE CORPORATION

Despite the presence of many international development banks, there is still a huge shortfall in the finances required in developing countries that these institutions are unable to meet. A financing institution such as an SFC can play an important role in bridging this gap.

This SFC’s mandate would be to provide access to financing in the solar energy sector, especially in emerging and least developed countries. These funds would be provided across the entire supply chain—from project developers to end users. It will help provide long-term financing at affordable rates to provide funding of solar projects across the member countries. It will also help to form links with cross-South development financial institutions. The scope of
the SFC will be from individual small projects to utility-scale projects covering all geographical areas.

1. Leverage public finance to attract private finance by sharing the risk involved in projects.
2. Help source both domestic and international funds for investment through different financial instruments such as loans, grants, and equity.
3. Seek to tap into and mobilise institutional investors such as sovereign wealth funds, pension funds, philanthropies to invest in the solar sector.
4. Enabling and expanding livelihood options for end-users through solar products such as solar pumps, solar-powered sewing machines, solar milk
   chillers, and fishing boats.
5. Seek commercial rates of return through equity investments in mature markets in the EU or US that can be reinvested in emerging and LDC markets.

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