The Government of India has ambitious plan to scale up installed capacity of decentralized roof top solar projects to 40 GW by 2022. This entails investment requirement of roughly about $ 25 Bn. Further, additional investment of about $ 1.5 Bn for creating capacity and meeting working capital requirement of intermediaries like EPC companies, OEM manufacturers etc.
Currently, majority of the funding for roof top projects are raised through credit lines provided by multilateral/bilateral agencies like KFW, World Bank and ADB through PSU banks and RESCO’s. Such a large scale of investments is difficult to mobilize from just few sources of capital providers, hence there is requirement of bringing in private capital.
Blended finance is a structuring approach that uses catalytic capital from public or philanthropic sources to scale up private sector investment in emerging markets/Sectors, resulting in efficient use of development or philanthropic finance to create large positive impact. In these transactions, concessional funds act as risk capital (sub-ordinate or equity tranche) that is subject to first losses or that provides credit enhancement through guarantees and insurance products. Basic idea is through the structural credit enhancement provided by public or philanthropic sources (which comes at lower or zero cost), fund or vehicle will be able to tap into more commercial sources of capital which were otherwise not interested in lending to the segment. Due to the availability of credit enhancement, the blended financing would be available at a rate that is typically available for higher rated issuers or structures.
Caspian’s observations in lending to the clean energy sector
Caspian’s multi sector debt fund invests in professionally managed high growth enterprises across all the impact sectors including clean technology. Such investments entail relatively higher level of business models or product/technology risks arising on account of limited track record and/or sub optimum scale of operations resulting in cash burn or low/limited profitability.
To make debt investments in such relatively higher risk enterprises or business models would require higher risk appetite, however, pure debt funds [unlike venture debt funds which seek upsides from equity warrants/options] are generally low risk low return vehicle’s, resulting in mismatch of investment risk and fund/investor risk appetite. Some of those risks can also be perceived risks of the investor due to limited past experience in the sector/ business model.
Such risks are further amplified in clean tech sector in India due to limited track record of enterprises in raising external equity resulting in thin capital cushion’s to absorb losses. Despite of low odds, Caspian has been able to take leap of faith in making investments in newer business models and assume higher risk than natural ability of the fund due to availability of portfolio guarantee / risk sharing arrangements from agencies like Rabo Foundation and USAID which provide down side protection in such transactions, which enabled us to commit/invest capital in new sectors and new age business models.
Downside of Blended Finance structures
Purpose of blended finance structures is to mobilize larger quantum of private funding by leveraging concessional funds from philanthropic or development agencies. However, such financing do have the ability to distort the market pricing resulting in crowding out private capital if the concessional funding is used as a refinance or direct finance line instead of a line to provide credit enhancement. This is contrary to the original philosophy of the blended finance structure. While concessional funding are required to demonstrate viability of the projects or business models during the market creation phase, but such concessional funding should be gradually phased out to allow commercial capital to phase in and allow competitive market forces shape the market.
Concessional financing provided by multilateral/bilateral agencies through public sector banks/FIs financing roof top projects. Which is essential during the early stage due to commercial viability gap. However, as the commercial viability of the solar roof top projects is established, these concessional financing's structures needs to be phased out allowing commercial capital from Bank’s and NBFCs to replace them. In the current context, other Banks and NBFCs will not be able to finance (even if there is an intent to do so) roof top solar projects as their commercial source of funds are not competitive against concessional financiers. During the market expansion phase, such concessional financing structures can be replaced by credit enhancement (guarantee’s) structures which all private investors can utilize to finance development projects creating level playing field for all commercial lenders.