{"id":6255,"date":"2015-06-18T00:48:12","date_gmt":"2015-06-18T00:48:12","guid":{"rendered":"https:\/\/climatepolicyinitiative.org\/?post_type=cpi_publications&p=6255"},"modified":"2026-05-24T00:53:01","modified_gmt":"2026-05-24T00:53:01","slug":"reaching-indias-renewable-energy-targets-cost-effectively-a-foreign-exchange-hedging-facility","status":"publish","type":"cpi_publications","link":"https:\/\/www.climatepolicyinitiative.org\/id\/publication\/reaching-indias-renewable-energy-targets-cost-effectively-a-foreign-exchange-hedging-facility\/","title":{"rendered":"Reaching India’s Renewable Energy Targets Cost-Effectively: A Foreign Exchange Hedging Facility"},"content":{"rendered":"
Executive Summary<\/h5>\n

India has ambitious renewable energy targets for 2022,\u00a0but because of the government\u2019s limited budget, a\u00a0cost-effective policy path is crucial to achieving those\u00a0targets. Achieving India\u2019s renewable energy targets\u00a0cost-effectively faces two key barriers \u2013 a shortage of\u00a0debt and inferior terms of debt (CPI, 2012). The\u00a0estimated availability of private capital for infrastructure\u00a0investment during the 12th Five Year Plan is 27% lower\u00a0than what\u2019s required (RBI, 2012). In addition, inferior\u00a0terms of debt, specifically high cost, short tenor, and\u00a0variable interest rates, increase the cost of renewable\u00a0energy in India by 30% compared to the US (CPI, 2012).\u00a0This directly increases the cost of government support.\u00a0More debt at attractive terms, specifically reduced cost,\u00a0extended tenor debt, is needed to achieve India\u2019s\u00a0renewable energy targets.<\/p>\n

Foreign debt can increase debt available for renewable\u00a0energy and can also provide a cheaper source of capital.\u00a0However, when a renewable energy project is financed\u00a0by a foreign loan, it requires a currency hedge to protect\u00a0against the risk of devaluation. Market-based currency\u00a0hedging in India is expensive, adding approximately 7\u00a0percentage points to the cost of debt. This makes\u00a0fully-hedged foreign debt nearly as expensive as\u00a0domestic debt.<\/p>\n

Reducing the cost of foreign debt by reducing the\u00a0currency hedging cost can mobilize foreign capital and\u00a0spur investments in renewable energy by reducing the\u00a0cost of capital. This would then reduce the delivered\u00a0cost of renewable energy, making renewable energy\u00a0more competitive with electricity generated from fossil\u00a0fuels (CPI, 2012), as well as reduce the government cost\u00a0of support (CPI, 2014).<\/p>\n

The Indian government has recognized the role that\u00a0cheaper currency hedging mechanisms can play in expanding\u00a0renewable energy capacity.\u00a0There is an argument that governments should bear\u00a0currency risk in some strategic situations, and participate\u00a0in the provision of currency hedging. One reason\u00a0is that macroeconomic conditions are key drivers of\u00a0currency movements and foreign exchange rates, and\u00a0government policy can influence macroeconomic\u00a0conditions.<\/p>\n

In the case of India, another argument for\u00a0government-sponsored currency hedging is that bearing\u00a0the currency risk for renewable energy offsets the risk\u00a0the government (and the economy as a whole) takes on\u00a0the currency risk related to future imported fossil fuel\u00a0purchases. This is particularly relevant for imported\u00a0coal, which is the marginal fossil fuel that additional\u00a0renewable energy is likely to replace (CPI, 2015).<\/p>\n

The Indian government has shown interest in providing\u00a0a government-sponsored exchange rate hedging\u00a0facility. However, the design of the facility would be a\u00a0large undertaking that has to be carefully considered,\u00a0given that currency movements can be uncertain and\u00a0volatile. In providing currency hedging for renewable\u00a0energy projects, the government might consider the\u00a0following questions: what are the expected costs and\u00a0risks of providing such hedging? How can the\u00a0government cover unexpected and extreme movements\u00a0in foreign exchange rates? And what is the market risk\u00a0premium for taking currency risks?<\/p>\n

We provide insights into these questions by examining\u00a0a government-sponsored foreign exchange rate (FX)\u00a0hedging facility, which could be a cheaper and effective\u00a0currency hedging mechanism. Under an FX hedging\u00a0facility, the government can provide project developers\u00a0or off-takers (depending on the power purchase\u00a0agreement) a currency hedging solution through a\u00a0standalone fund that covers debt payments for\u00a0underlying USD loans.<\/p>\n

We analyze this FX hedging facility using a representative\u00a0probabilistic model, whose key parameters are\u00a0derived from the history of the INR-USD exchange rates,\u00a0and of the future movements of foreign exchange rates.<\/p>\n

Expected Cost of the FX Hedging Facility<\/h5>\n

The FX hedging facility, with an expected cost of 3.5 percentage points, may reduce hedging costs by nearly 50%, and the cost of government support by up to 54%.<\/p>\n

Our analysis reveals that the expected cost \u2013 or the average cost across all potential outcomes represented by our probabilistic model \u2013 to provide a 10 year currency hedge via the FX hedging facility is approximately 3.5 percentage points per year, 50% below market rates. At the current capital cost of solar energy, this amounts to 16% of the underlying loan amount.<\/p>\n

The FX hedging facility would reduce the cost of renewable energy by reducing the cost of debt and, therefore, the cost of capital through a reduction in the cost of debt and an increase in the debt to equity ratio. This would then reduce the total cost of support \u2013 the total subsidies required \u2013 for renewable energy (CPI, 2014).<\/p>\n

The implications for the cost of renewable energy as well as for the cost of support for the government are:<\/p>\n