An inability to recycle capital is one of the most important issues to hobble the renewable energy infrastructure in India. A few fixes could enhance the attractiveness of the sector for investors.
By Naveen Khandelwal
Evolution of any industry is critically dependent on various states of capital raising or infusion like developmental or seed capital, growth capital from private investors and institutional investors and then finally the holy grail of public capital markets, which is the most permanent nature and cost efficient pool of capital.
This journey of reaching permanent capital takes different time periods for different industries, depending upon sector evolution trajectory and maturity. Nevertheless, undermining the importance of recycling of capital from one class or category of investors to the next one can prove to be disastrous and does not bode well for any sector.
Investor behaviour and preferences too are expected to change owing to uncertainties and vulnerabilities presented by Covid-19. Talking specifically about renewables, it has been facing the lack of recycling across all three avenues of capital - debt capital, equity capital and asset block recycling.
The renewables sector, however, has done phenomenally well in the last few years. Even during COVID-19, the sector has not got affected that adversely as electricity demand drop has been temporary and it has resumed at a fast pace. Further, the ‘must run’ status accorded and reinforced by the Ministry of New and Renewable Energy (MNRE) and continuous payments by discoms helped the industry during this tough period.
There is a view that post-COVID-19, various stakeholders, including policy makers as well as business executives, would pursue further greener energy choices while rebuilding and resuming growth.
Therefore, if we were to catalyse the fund deployment into the sector, which is crucial to realize the dream of energy transition, from black/brown energy to green energy, sooner than later, we need to look deeper into the situation of and issues affecting the capital recycling and address them at the earliest.
EQUITY
Due to federal government support, favorable policies and regulatory framework and the sheer size of the opportunity, India has been able to attract good risk capital for the last five to seven years.
As the sector evolved and competition intensified, it witnessed good growth coupled with gradual de-risking. Even though returns from the projects were diminishing to mid-teens range, investors continued to support the momentum.
However, most investors have been found waiting for a long time now to release their equity capital and return the capital to their shareholders and investors. Not many good exits have happened for the early investors from any of the potential options -- be it an initial public offering (IPO), secondary trade sales or strategic buyouts.
This dearth of exit options is now adversely affecting the availability of further risk or development capital. This is expected to aggravate in the post-COVID-19 world where risk aversion and providing for uncertainties and vulnerabilities is going to be a big factor in investors’ decision making.
One could always blame typical valuation mismatches for such an issue. However, it has more to do with the changing and inconsistent narrative of the sector and regulatory and policy support for exit structures and options.
Despite compelling long term fundamentals of the sector, transactions have been affected due to undesirable negative narrative caused due to indiscriminate payment delays by discoms, inadequate redressal of land and evacuation issues and inconsistencies in permission processes of different states.
The inconsiderate imposition of Sustainable Development Goals (SDGs) have also affected equity cash flows adversely. The absolutely avoidable efforts at purchase power agreements (PPAs) renegotiation by some counter-parties and the unaddressed lack of debt capital all stymie the sector’s growth.
These concerns, along with some regulatory and taxation issues in exit options and structures, have affected decision making by new and existing investors alike. As a result, equity capital recycling too is affected.
DEBT
Moving on to debt, initially high demand for debt capital was supported by underwriters like private sector banks and non-banking finance companies (NBFCs). However, as these underwriters of debt faced a lot of issues in down-selling or recycling their own exposures, to deeper and longer tenor pools of debt capital like public sector banks or long term capital financial institutions or debt capital markets, availability of debt capital in the sector became an issue.
This issue has worsened due to COVID-19 as concerns around liquidity, asset liability mismatch and risk aversion have further increased.
Regarding Indian debt capital markets, not much has changed despite numerous discussions and efforts. Improved depth of the markets in terms of size, volume, liquidity and tenor has been a distant dream in general. For renewable debt papers, the situation has been particularly disappointing. Renewable papers suffer lower rating range due to poor financial health of PPA counterparties, which makes many investor classes ineligible to invest in these papers.
Another Achilles heel has been big asset-liability mismatch issues for most of the market participants, as Indian markets are highly illiquid beyond five years. We witnessed Covid-19 expose vulnerability of Indian debt capital markets, wherein participants experience major liquidity issues and complete risk aversion.
Though foreign currency debt, especially USD Bonds, appeared to have offered a good ray of hope in 2017 and again in early 2020 to recycle some of existing debt, regulatory challenges, hedging cost consideration, high volatility in pricing and refinancing risk are a few major concern areas that still remain.
WAY FORWARD
When looking into the future, the proposed amendment to the Electricity Act seems to be a good harbinger for renewables. Hopefully, project debt papers would get a couple of notches up, if most of the proposed provisions were to be implemented or made effective, even in the next few quarters. Moreover, Rs. 90,000 crore of special liquidity infusion package for discoms would give much needed breather. Performance improvement of discoms and structural change targets for the sector would be long term positives.
In terms of other solutions, a few could be:
-Promotion of credit enhancement structures, to allow renewable debt papers to dip into more liquid pool of higher rated papers.
- Setting up a few more financial institutions, to offer long term takeout financing, like India Infrastructure Finance Company (IIFCL), to recycle the mature portfolio of commercial banks and NBFCs
- Permission for insurance companies, pension funds and provident funds to hold up to 5% of their assets in debt against state discom PPAs
- Regulatory easing of ECB (external commercial borrowing (ECB) guidelines for infrastructure projects, at least for high quality select institutional investors
- Addressing few remaining issues in implementation of infrastructure investment trusts (InVITs)
These steps could reinvigorate optimism of some of the existing investors and initiate a virtuous cycle through capital recycling for the sector and attract more and stronger players and eventually make the wheels of energy transition turn much faster.
(The author has over 15 years of experience in the power sector in the areas of corporate finance, equity investments, capital raise transactions, M&A, growth strategy, project finance and general management. He is currently Chief Investment & Strategy Officer at Hero Future Energies. He has played a pivotal role in the growth of HFE’s renewable portfolio to close to 2.5 GW, comprising onshore wind, solar photovoltaic (PV), rooftop solar & international projects. He was also instrumental in launching the country’s first certified domestic green bond for the expansion of HFE’s wind portfolio)
