Reaching India’s Renewable Energy Targets Cost-Effectively: A Foreign Exchange Hedging Facility

Arsalan Farooquee and Gireesh Shrimali

MPRA Paper from University Library of Munich, Germany

Abstract: In India, a significant barrier to market-competitiveness of renewable energy is a shortage of attractive debt. Domestic debt has high cost, short tenors, and variable interest rates, adding 30% to the cost of renewable energy compared to renewable energy projects elsewhere. Foreign debt is as expensive as domestic debt because it requires costly market-based currency hedging solutions. We investigate a government-sponsored foreign exchange facility as an alternative to reducing hedging costs. Using the geometric Brownian motion (GBM) as a representative stochastic model of the INR–USD foreign exchange rate, we find that the expected cost of providing a currency hedge via this facility is 3.5 percentage points, 50% lower than market. This leads to an up to 9% reduction in the per unit cost of renewable energy. However, this requires the government to manage the risks related to unexpected currency movements appropriately. One option to manage these risks is via a capital buffer; for the facility to obtain India's sovereign rating, the capital buffer would need to be almost 30% of the underlying loan. Our findings have significant policy implications given that the Indian government can use this facility to make renewable energy more competitive and, therefore, hasten its deployment.

Keywords: Foreign exchange risk; Renewable energy; Capital buffer; Energy Finance (search for similar items in EconPapers)
JEL-codes: F3 F31 Q4 Q48 Q5 (search for similar items in EconPapers)
Date: 2015-06
New Economics Papers: this item is included in nep-ene
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