Financing renewable power in India via Arbitrage
Rewa solar power park in India will receive debt finance at just 0.25% from the World Bank. A few weeks back, a competitive auction for the 750 megawatt (MW) solar power park in Rewa, Madhya Pradesh, yielded the lowest-ever tariff for a solar power project in India. This project and the finance package from the World Bank represent the biggest challenge for solar energy in India: Finance. The interest rates from Indian banks can easily reach 8%-9%. This is partly due to the policy of Raguram Ragan, the former head of the Indian central bank, who fought to reduce the high inflation in India. Another reason for the high interest rate, probably, is the high risk of doing business in India.
These high interest rates are in sharp contrast to other parts of the world. The Japanese and European central banks are lending money at zero (or close to zero) interest rates. The interest rates of the American Federal reserve are also low, and will remain low even after the long overdue rate increase. In china, which also has huge foreign currency reserves, the interest rate is closer to 4%-4.5%.
These interest rate differences present a big opportunity for profits due to arbitrage from loans to renewable energy projects (especially solar power plants) in India. The importance of interest rates is nicely explained by Josiah Child (one of the directors of the English East India Company): “all nations are at this day richer or poorer in exact proportion to what they pay, and have usually paid, for the interest of money….All other things being equal, a Dutch company could borrow at a 4% interest rate two and a half times more money than an English company could at a 10% rate”. What was true about 500 years ago is still true today. Money that is lent by the Japanese or European central banks at 0 percent can be lent to projects in India at 4%-5% (or more) and provide much needed finance to Indian developers and profits for European/Japanese/Chinese/American banks.
Why finance renewable energy, or solar power plants? One reason is that the Indian government is highly supportive of these projects, following the plan of Indian Prime Minister Mudi to add 100GW of solar power in India in the coming years (The Indian government has also waived off several add-on charges faced by renewable energy projects. These include wheeling, cross-subsidy, banking, and other charges. These charges will be waived-off for solar power projects commissioned by June 30th, 2017, and for wind energy projects commissioned by March 31st, 2019). Another reason is the high growth rates (~7%) of the Indian economy, which are among the highest in the world. But there is a simpler reason for such an investment: these solar power plants have basically captive consumers. These consumers are not only the millions of Indians that currently do not have access to electricity. But rather, the captive consumers are the many Indian businesses. Industrial consumers are required to pay an additional surcharge over and above the electricity tariffs in order to subsidize the tariffs for residential consumers. The overall electricity tariff faced by industries is thus substantially higher than the cost of generation of solar power. Not only are the electricity prices for Indian businesses is very high, the electricity is very unreliable with numerous power shortages every year.
It is very attractive (not to mention competitively essential) for Indian businesses to disconnect from the Indian central utilities and buy power directly from solar power plants. The only thing delaying massive exodus from Indian utilities is the high costs of energy storage that is used to compensate for the intermittent nature of solar energy. The Indian government has realized this and is promoting energy storage projects.
Another thing that makes investment in India attractive in the coming year or two is the cancellation of the popular Indian note (500 Rs and 1000 Rs) that has let to large amounts of the Indian money to go out of circulation (due to unreported black money that is now worthless). This monetary action (basically the opposite of the “quantities easing” from the European central bank and the American Federal reserve) will most likely lead to lower inflation rates in the coming year or two (although there are no guaranties here).
European and Japanese bank are not the only ones that can gain from investment in Indian solar. Chinese solar panel manufacturers will also profit as they use their over-capacity to dominate the Indian market. India is trying to promote local content, but it is doubtful that Indian manufacturers can reduce solar panel as cheap as the Chinese and even more doubtful that Indian project developers will buy more expensive panel just because they are local (even if the government mandates local content).
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