Limits on borrowers, cost efficiency, stable cash flows, and credit risks. These factors will determine whether project finance becomes the optimal route to unlock the full potential of India's renewable energy market.

Investor questions about project finance in India include the categorization of restricted groups, the inclusion or exclusion of non-recourse debt in financial analysis, the credit risks of two-tier structures, and the counterparty risk associated with state utilities.

They also want to know about the implications of increased exposure to commercial and industrial customers and analyze the currency risk for U.S. dollar debt in Indian projects.

We address these questions in this article, which complements "Is Project Finance The Way Forward For Australian Renewables?"

Frequently Asked Questions

How do you determine whether a restricted group is a corporate entity or a project finance entity?

Several factors help determine the categorization. The bankruptcy remoteness of the issuing vehicle, the ringfencing of cash flows, restrictions on nature of assets, availability of security, cash waterfall, distribution lock-ups, limitations on debt and other covenants can vary significantly between different restricted groups.

Tighter restrictions will necessitate a credit approach that is closer to that applied to project finance entities. We will likely apply our corporate methodology in the case of loose restrictions with significant dependence on management plans/strategy.

We have seen several restricted group issuances out of India. Consider Greenko Energy Holdings (no longer rated). We didn't differentiate the credit risks for different restricted group issuance since Greenko holdco guaranteed all structures, lacked tight restrictions, and could move assets from one restricted group to another (if incurrence covenants were met).

Are your ratings always tied to the parent or are there examples of rating differentiation?

Renew Power Ltd. Restricted Group is another (no longer rated). Its restricted group had tighter restrictions on cash flow waterfall, so we considered the restricted group's stand-alone credit profile, while factoring in the impact on the group's credit profile. The structure also allowed loans/dividends and lacked some project finance features.

Continuum Energy Levanter Pte. Ltd. issued a bond that had mostly project finance features. However, the bond has a cross-default clause with Continuum Green Energy Ltd. and thus we view the credit quality of the debt as linked to that of the parent/sponsor.

There are also the restricted group issuances by the Adani group. Parampujya Solar Energy Private Ltd. and Adani Green Energy Ltd. Restricted Group are a distinct portfolio of project finance ringfenced assets with different cash flows, waterfall, covenants, and security package. In such structures, we delink the rating from the parent, Adani Green Energy Ltd.

What determines whether you include or exclude non-recourse debt in your financial analysis?

We have seen non-recourse project-level funding by various renewable players. However, for sponsor/promoter-driven platforms such as Greenko and Renew Power we have seen instances of parent/group support to service project-level debt in view of reputational risk and broader bank-funding relationships at the group level. As a result, we generally analyze these entities on a consolidated basis.

In contrast, project developers such as Vena Energy Capital Pte. Ltd. have refrained from supporting project-level debt even if a project faces financial difficulty in servicing its debt, as observed in India. As a result, for Vena we focus on the quality of distributions of residual cash flows from operating companies rather than consolidated leverage when we assess Vena's financial health.

What are the credit risks for two-tier structures, especially orphan special purpose vehicles (SPVs) in India?

Two-tier structures have emerged in India due to interest rate caps imposed by the central bank, the Reserve Bank of India, on direct issuances of foreign currency debt from operating entities. Typically, these structures include a foreign currency bond issued by an SPV, which is used to fund a rupee-denominated loan granted to an Indian operating entity. The rupee cash flows from the operating entity are the source of repayment for the SPV foreign currency bond.

While the underlying operational Indian assets are the key drivers of the credit risk, we believe incremental analysis is required because of the two-step multi-jurisdiction structure with Indian rupee cash flows from operational assets passed on to the foreign SPV for conversion into U.S. dollar payment to debtholders.

We review the speed of pass through to conversion, the form and level of the hedge, the credit quality of the hedging counterparty, and additional termination events. This is crucial for orphan SPVs because while rupee cash flows may be sufficient to cover the underlying rupee debt, an incomplete hedge or the termination of a hedge can result in insufficient foreign exchange to pay the SPV debtholders. That is, an otherwise performing transaction suddenly runs a risk of default.

Orphan SPVs lack a larger group parent with a direct mechanism of legal support. On the other hand, for direct issuance by corporate entities, the parent has legal mechanisms and financial tools available to support foreign exchange risk from incomplete hedge (which we factor in in our finacial assessments). In project finance structures, we will focus on mechanisms for the transfer of and conversion of rupee funds as well as the impact of hedging to assess the risk of such structures.

Do you see counterparty risk associated with state utilities as systemic in India?

No. The value chain of power supply differs materially in India because there are many distribution companies across various states. Further, despite weak financial health, many state utilities continue to prioritize operational payments for the power they consume. The key risk is the delay in the collection of receivables. While some states such as Andhra Pradesh have tested this hypothesis by trying to renege on agreed price under power purchase agreements, courts in India have always upheld the sanctity of the contracts.

How do you incorporate such risks in your credit assessment?

Risk from exposure to state utilities differs according to whether it's a corporate or project finance transaction, in our view. We believe corporates with solid diversification across multiple states have various avenues to mitigate their counterparty exposure. These measures include (1) the ability to organically or inorganically expand the portfolio and alter counterparty exposure with time; and (2) tap into working capital facilities or sponsor support during delays in receiving payment.

On the other hand, project finance structures have much higher exposure to counterparty risk. This is because of their relative inability to diversify the exposure by altering portfolio composition. And their unwillingness to recontract at the cost of higher tariffs and existing relationships. Thus, the credit profile of the weak discoms can constrain the project ratings, subject to level of exposure and our view on insulation of credit profile (up to one notch).

What are the credit implications for issuers with increasing exposure to commercial and industrial (C&I) customers in India?

C&I contracts are usually shorter in tenor, ranging from five to 20 years. This poses potential renewal and tariff renegotiation risk. Further, in many cases the price is linked to grid prices and reset annually. We believe C&I tariffs expose a project to some market risk in terms of price and volume, particularly if contracts are not renewed or there is churn.

However, mitigating factors may include:

• Lower tariffs (than the grid) lead to competitive pricing and limits customer churn;
• Tariffs with annual inflation adjustments;
• Expected increases in electricity demand and grid-tariffs in the medium to long term; and
• Diversification across multiple parties (often with better credit quality and payment track record than the state distribution companies).

Group captive projects--whereby a group takes up an equity stake in a power plant for its own consumption--further benefit from counterparty's part ownership of the asset.

We believe the market structure in India with cross subsidization of free power for agriculture and subsidized tariff to residential customers with higher tariff on C&I customers will require independent review of each state market for price forecasts. We will review the market structure in each state, and seek independent expert reports on the evolution of market demand-supply and forecast prices.

Indian projects earn Indian rupee-denominated revenue whereas the bond is denominated in U.S. dollars. How do you assess currency risk for U.S. dollar debt?

Indian projects with rupee cash flows and U.S. dollar debt adopt different hedging strategies. For projects that adopt total return swap for the same tenor as the U.S. dollar debt, the counterparty risk of the banks providing the hedge is important.

However, in some cases projects have issued long-term debt extending well beyond the five- to 10-year range in which hedging contracts are available in the Indian market. In such cases, we also consider potential higher hedge costs, and hedge rollover risk for the swap, given the shorter hedge tenor than debt tenor.

We also estimate foreign exchange rates, mark-to-market payouts (if relevant), and hedge costs for both our base case and the downside case. Higher hedge costs and mark-to-market payouts can lead to lower debt service coverage ratios, which may affect the rating.

Some sponsors use options in the form of call spreads or at-the-money forwards. These options are cheaper than forwards but result in foreign exchange exposure either up to the strike price or from the strike price based on management's take on rupee depreciation against the U.S. dollar and the chosen hedging strategy. We believe such instruments present additional currency risk, which need to be factored in credit assessment.

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Related Research

• Credit FAQ: Is Project Finance The Way Forward For Australian Renewables?, Feb. 22, 2024