Sustainability for MSMEs: The rooftop solar sector has remained largely untapped. Against the government’s target of installing 40 GW of RTS power projects by 2022, India has achieved an operational RTS capacity of only 7.7 GW as of June 2021. This is nowhere close to the envisaged target.
Highly leveraged existing borrowing structures of MSMEs often constrain them from absorbing additional debt for rooftop solar projects. (Image: pixabay)
By Shreyans Jain
Sustainability for MSMEs: India is making giant leaps in the renewable energy sector. With a total installed energy capacity of 150.54 GW (as of November 30, 2021), it stands at the fourth position in the world in terms of installed capacity. This includes 48.55 GW of solar, 40.03 GW of wind, 4.83 of small hydropower, 10.62 of bio-power, and 46.51 GW of large hydropower. During the last 7.5 years, India’s renewable energy capacity has grown 1.97 times, with solar energy expanding over 18 times.
The rooftop solar sector, however, has remained largely untapped. Against the government’s target of installing 40 GW of RTS power projects by 2022, India has achieved an operational RTS capacity of only 7.7 GW as of June 2021. This is nowhere close to the envisaged target. Bridging this gap in the next few years would require integrated efforts from all participants in the rooftop solar ecosystem, including consumers, developers, policymakers, lenders, and regulators.
One area of opportunity to achieve this target lies with micro, small and medium enterprises (MSMEs). The MSME segment accounts for about 48% of the total energy consumed by India’s industrial sector. The rooftop solar installation potential within the MSME segment is estimated to be about 15 GW (37.5% of the 40 GW target). A typical MSME grid-connected rooftop solar system has a capacity of 10-100 kW and costs about ₹ 38,236/kW as per the Ministry of New and Renewable Energy. It has low maintenance and servicing requirements, and the system is usually warranted for output peak watt capacity, which should not be less than 90% at the end of 12 years and 80% at the end of 25 years. The owner can recover her initial investment in a period of just four-five years.
Clearly, MSMEs can play a very important role in employment generation while decarbonizing the economy’s supply chain. However, despite a significant market potential and a strong business case to shift from conventional grid power and fossil fuel-based sources of power to rooftop solar to meet their energy needs, MSMEs have so far been hesitant in embracing non-conventional sources of energy.
This is primarily due to structural and institutional barriers like lack of access to low-cost debt financing due to credit risk of the consumer, challenges in implementing net metering, high transaction cost due to the small size of projects, and concerns about legal enforceability of contracts and collateralization of borrower’s assets. Addressing these challenges can unlock a huge lending opportunity for Non-Banking Financial Companies (NBFCs), Small Finance Banks (SFBs), and commercial banks and pave a low carbon pathway for India to achieve the target of net-zero carbon emissions by 2070.
Challenges in the sector
Lack of market awareness about the financial and environmental benefits of rooftop solar has led to slow uptake in the sector. Particularly in the aftermath of the pandemic, MSMEs are left with a Hobson’s choice – whether to invest their scarce working capital on their core business operations (purchase of raw material, machines, etc.) for immediate returns or to install solar and tie up their funds for a long period of time to realize the potential benefits of their “green” investment.
The situation is exacerbated by the poor creditworthiness of MSME borrowers which acts as a major challenge for institutional lenders to finance rooftop solar projects. The sector is usually characterized by the non-availability of historical financial data and payment track record of MSMEs, lack of formal credit ratings, high rates of default, and uncertainty about the sustainability of business operations.
The absence of a secondary marketplace to resell or redeploy the system in case of an event of default further erodes the value of the collateralized assets. Decommissioning of the fragile solar equipment is accompanied by degradation of system performance and lapse of associated warranties.
Most lenders underwrite credit risk in their product offerings. The perceived risks associated with policy uncertainty, technical performance of the installed system, and events that are difficult to discover like the risk of MSME wanting to relocate its business, the risk of the nature of MSME’s roof profile changing midway through the loan, the neighbour coming up with a higher built structure in the vicinity etc. are, however, difficult to underwrite.
Such risks cannot be mitigated through a credit guarantee mechanism and are not priced suitably in the current financial offerings. There is poor innovation in the development of dedicated lending products that can be made available at attractive terms of finance. Most MSMEs thus end up borrowing from non-institutional lenders and local loan sharks at arbitrary rates of interest.
India’s rooftop solar market is highly fragmented due to low entry barriers. Due to the presence of a large number of players, the quality of installation and workmanship varies significantly. There are challenges associated with developing acceptable standards for module quality, output generation, and system specifications.
There is little understanding of the structural impact of improper installation on MSME rooftops and adverse system performance resulting from it. This fuels dissatisfaction among consumers and makes it nearly impossible for solar developers to penetrate existing and new markets with their solutions. Furthermore, the regulatory landscape for rooftop solar is highly unpredictable with state electricity regulators coming up with different provisions every year. Once a loan has been underwritten, financers are seldom concerned about regulatory flip-flops and are only interested in the timely repayment of principal and interest by the borrower.
Finding sustainable solutions
Highly leveraged existing borrowing structures of MSMEs often constrain them from absorbing additional debt for rooftop solar projects. There are, however, solutions available to improve the uptake of solar. Firstly, an institution that provides credit guarantee on the loans extended to MSMEs and covers 50-60% of the loan amount in case of default needs to be set up. This institution can further be tasked with providing credit ratings to the MSME borrowers based on their repayment of these loans. This will improve their creditworthiness.
Secondly, a secondary marketplace needs to be created to facilitate the resale and redeployment of defaulted solar assets. Participants in this market can offer packaging and assurance as services by inspecting the quality of modules and providing a fresh warranty for 3-4 years on the refurbished equipment.
Thirdly, insurance can act as a tool to mitigate the perceived risks associated with government policy, system performance or any other factor intrinsic to the borrower. Besides, financers need to come up with innovative models of financing. For instance, the MSME borrower’s equated monthly instalments could be tailored in such a way that the monthly cash outflow for servicing the loan is equivalent to the monthly cost savings on electricity from deploying RTS at its premises.
Similarly, extending short-term loans to solar developers will enable them to enter into power purchase agreements of similar duration with MSME off-takers and reduce credit risk substantially. Finally, state electricity regulators should come up with a compensation mechanism in which power distribution companies are incentivized to invest in upgradation and modernization of the grid and at the same time compensated for these investments from the lower average power purchase cost for purchasing electricity from rooftop solar sources.
The government has identified energy transition and climate actions as one of the visions for India@100. It has announced a number of near-term and long-term measures to finance the transition to a “pollution-free India with green Mother Earth and blue skies”. Rooftop solar offers one such opportunity that can help the country further its climate agenda and decarbonize the economy.
Shreyans Jain is Senior Analyst – Climate Finance at Climate Policy Initiative. Views expressed are the author’s own.