“Why MSMEs are reluctant to adopt unconventional energy sources like rooftop solar”
By Shreyans Jain
Sustainability for MSMEs: India is making giant strides in the renewable energy sector. With a total installed energy capacity of 150.54 GW (as of November 30, 2021), it ranks fourth in the world in terms of installed capacity. This includes 48.55 GW of solar, 40.03 GW of wind, 4.83 GW of small hydro, 10.62 of bio and 46.51 GW of large hydro. Over the past 7.5 years, India’s renewable energy capacity has increased 1.97 times, with solar power increasing more than 18 times.
However, the rooftop solar sector has remained largely untapped. Compared to the government’s target of installing 40 GW of RTS power projects by 2022, India reached an operational RTS capacity of just 7.7 GW in June 2021. This is far from the intended goal. Closing this gap over the next several years would require integrated efforts by all participants in the rooftop solar ecosystem, including consumers, developers, policymakers, lenders, and regulators.
One area of opportunity to achieve this goal lies in micro, small and medium-sized enterprises (MSMEs). The MSME segment accounts for about 48% of the total energy consumed by India’s industrial sector. The potential for rooftop solar installation in the MSME segment is estimated at around 15 GW (37.5% of the 40 GW target). A typical MSME grid-connected rooftop solar system has a capacity of 10-100kW and costs around ₹38,236/kW according to the Ministry of New and Renewable Energy. It requires little maintenance and upkeep, and the system is generally guaranteed for output peak power capacity, which should not be less than 90% after 12 years and 80% after 25 years. The owner can recoup their initial investment in just four to five years.
Clearly, MSMEs can play a very important role in creating jobs while decarbonizing the supply chain of the economy. However, despite significant market potential and a strong business case for switching from conventional grid electricity and fossil fuel-based energy sources to rooftop solar to meet their energy needs, MSMEs have so far now hesitate to adopt unconventional energy sources.
This is mainly due to structural and institutional barriers such as lack of access to low-cost debt financing due to consumer credit risk, difficulties in implementing net metering, high transaction costs in due to the small size of the projects and concerns about the legal enforceability of contracts and security of the borrower’s assets. Addressing these challenges can open up a huge lending opportunity for Non-Banking Financial Companies (NBFCs), Small Financial Banks (SFBs) and Commercial Banks and pave a low-carbon pathway for India to achieve the goal of net zero carbon emissions by 2070.
Lack of market awareness of the financial and environmental benefits of rooftop solar has slowed its adoption in the industry. Particularly in the aftermath of the pandemic, MSMEs find themselves with a Hobson’s choice – invest their scarce working capital in their core business activities (purchase of raw materials, machinery, etc.) for immediate returns or install energy and tie up their fund for a long period to realize the potential benefits of their ‘green’ investment.
The situation is exacerbated by the low creditworthiness of MSME borrowers, which poses a major challenge for institutional lenders to finance rooftop solar projects. The sector is generally characterized by the unavailability of historical financial data and payment histories of MSMEs, the absence of formal credit ratings, high default rates and uncertainty about the sustainability of business operations.
The absence of a secondary market to resell or redeploy the system in the event of a failure further erodes the value of collateralized assets. The dismantling of fragile solar equipment is accompanied by a deterioration in the performance of the system and the expiry of the associated guarantees.
Most lenders underwrite credit risk in their product offerings. Perceived risks associated with political uncertainty, technical performance of the installed system and hard-to-discover events such as the risk that the MSME will want to relocate its business, the risk that the nature of the MSME’s roof profile will change mid-term of the loan, the neighbor coming with a higher built structure nearby, etc. however, are difficult to guarantee.
These risks cannot be mitigated by a credit guarantee mechanism and are not properly priced in current financial offers. There is little innovation in the development of dedicated loan products that can be made available on attractive financing terms. Most MSMEs therefore end up borrowing from non-institutional moneylenders and local loan sharks at arbitrary interest rates.
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The Indian rooftop solar market is highly fragmented due to low barriers to entry. Due to the presence of a large number of players, the quality of installation and workmanship varies considerably. 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 roofs and the resulting negative system performance. This fuels consumer dissatisfaction and makes it nearly impossible for solar developers to penetrate existing and new markets with their solutions. Additionally, the regulatory landscape for rooftop solar is highly unpredictable, with state electricity regulators coming up with different provisions each year. Once a loan has been underwritten, lenders are seldom concerned with regulatory flip-flops and are only interested in the timely repayment of principal and interest by the borrower.
Find lasting solutions
The existing highly leveraged debt structures of MSMEs often prevent them from absorbing additional debt for rooftop solar projects. However, there are solutions to improve solar absorption. First, an institution that provides a credit guarantee on loans granted to MSMEs and covers 50-60% of the loan amount in case of default should be set up. This institution may further be responsible for providing credit ratings to MSME borrowers based on their repayment of these loans. This will improve their creditworthiness.
Second, a secondary market must be created to facilitate the resale and redeployment of defaulted solar assets. Market participants can offer packaging and insurance as a service by inspecting the quality of modules and offering a new 3-4 year warranty on refurbished equipment.
Third, insurance can serve as a tool to mitigate perceived risks associated with government policy, system performance, or any other factor intrinsic to the borrower. In addition, funders should come up with innovative funding models. For example, the equivalent monthly installments of the MSME borrower could be adjusted so that the monthly cash outflows for servicing the loan are equivalent to the monthly savings on electricity costs resulting from the deployment of the RTS in its premises.
Similarly, providing short-term loans to solar developers will enable them to enter into power purchase agreements of similar duration with MSME buyers and significantly reduce credit risk. Finally, national electricity regulators should propose a compensation mechanism in which electricity distribution companies are incentivized to invest in upgrading and modernizing the network and at the same time compensated for these investments by the cost of lower average purchase price for buying electricity from rooftop solar. sources.
The government has identified energy transition and climate actions as one of the [email protected] visions. He announced a number of short and long-term measures to fund the transition to a “pollution-free India with green Mother Earth and blue skies”. Rooftop solar provides such an opportunity that can help the country pursue its climate agenda and decarbonize the economy.
Shreyans Jain is Senior Analyst – Climate Finance at the Climate Policy Initiative. The opinions expressed are those of the author.