Risk addressed: Off-taker and currency risk

Investment in renewable energy projects in India – especially utility-scale solar PV and wind – has been impressive over the last years, driven by a combination of improved policies, better financing terms, technology developments and regulatory changes (e.g., innovation in tender design). Yet, off-taker risk (payment delays from power purchase agreements, also called counterparty risk) and currency risk are still critical concerns for both equity investors and debt financiers investing in renewables in India. This case study highlights how payment security mechanisms and foreign exchange hedging facilities were effective in addressing these risks in India. 

Off-taker risk can be addressed by using a Payment Security Mechanism (PSM). Two methods are suggested for appropriately sizing PSMs for solar projects:

• Setting aside an amount to cover the expected loss from lack of payments from the off-taker. Findings concluded the size of the PSM to be less than 10% of the capital costs.
• Direct credit enhancement to raise the underlying debt rating to the highest level possible. Findings suggest the size of the PSM to be 10–20% of capital costs of the solar power deployed.

Currency exchange rate risk can be mitigated by using Foreign Exchange Hedging Facilities (FXHF). Two different ways are proposed to size FXHFs:

• Creating a contingency buffer to directly absorb tail foreign exchange risks (FX),
• Absorbing certain tranches of FX risk through market available FX swaps.

Leverage – i.e., the amount of private capital deployed per unit of public capital committed – was found to vary between three and nine, with the lower number corresponding to the first scheme and the higher number corresponding to the second scheme.

These solutions are likely to be useful for other developing countries, given that they may face similar risks. The implications of these solutions are manifold. First, the results provide concrete recommendations for the size of funded facilities that could address key risks to renewable energy projects. Second, they suggest that policymakers utilise public money to fund these facilities, while appropriately structuring them in consultation with stakeholders, such as ministries and financial institutions.