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By Gui Xiong Teo, CFA
We see a positive transformation in Indian renewables that could provide a significant opportunity for investors.
In August, India reiterated its commitment to draw 50% of its electricity generation capacity from non-fossil fuel sources, and to reduce its emissions intensity (based on GDP) to 45% below 2005 levels, by 2030.
Renewable energy is a crucial element in this plan. Over the last eight years, India’s renewable capacity grew from 76 Gigawatts to 152 Gigawatts and could accelerate further.
With burgeoning electricity demand, a spike in conventional thermal energy prices this year has increased India’s energy import costs, but with technological improvements and its unique geographical location, India is motivated to deploy its abundant solar and wind resources.
Multiple factors support the sector: Demand for renewable energy is set to increase as costs decline due to greater efficiency and technological improvement, and India has also begun shifting its supply chain onshore. As such, its expanding renewable ecosystem should prompt wider adoption.
Importantly, new regulatory policies compel power “off-takers” such as local distribution companies (discoms) to make more timely payments to renewable generation companies (gencos), improving the latter’s cash flows and lowering their receivable cycles.
In the past, despite repeated challenges by discoms to power purchase agreements, Indian courts have favored gencos, helping convince investors that their rights would be well protected.
In our view, as the renewable sector scales up and technology matures, funding sources will likely expand, at lower cost. Domestically, the Indian government is making more direct funding available through public financial institutions. Internationally, foreign direct investments from highly rated investors remain forthcoming.
Within the Asian bond universe, India renewables have seen a structural transformation. The sector’s average credit rating, which was B+ across three issuers in June 2017, was BB across 14 issuers in June 2022. We believe this improving trend is likely to continue.
Although debt and revenue currencies are mismatched, these issuers are FX-hedged at the outset of bond issuance, resulting in limited exposure to unexpected currency depreciation. Moreover, we believe potential rates of return provide ample cushion to absorb near-term interest rate increases.
In the near term, we expect sector cash flows to improve given favorable regulatory policies. In the medium term, we anticipate that gencos’ credit profiles will improve, albeit slowly as capex into the sector remains high.
In the long term, renewables could become an established form of low-cost and stable energy for long-term social and economic development. In our view, there are merits to an optimistic outlook for India’s renewable energy sector.
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