The South Asia Channel

Why India’s Airpocalypse May Be Here to Stay

India took on an unfortunate mantle this month, as scientists at Yale and Columbia universities released a study showing that the country's air is unhealthier than even China's infamous smog. It was just the latest illustration of the country's desperate need for diversified clean energy sources. A few weeks before, India's petroleum minister announced that high oil prices were pushing the country to the brink of an energy crisis.

The Indian government has announced ambitious plans to combat this crisis, including spending nearly $8 billion through 2020 to build an electricity grid to transmit power from wind and solar plants. It is also enlisting foreign help. India has eliminated caps on foreign direct investment and is offering tax breaks for investors in the clean energy sector.

The United States has also committed to playing a part. Cultivating clean energy alternatives will top the agenda when the United States and India resume their energy dialogue in March. Last June, USAID announced a "first-of-its-kind" partnership with U.S. institutional investor Northern Lights Capital Group to facilitate a $100 million investment in India's clean energy sector, aimed at funding up to 17 medium-sized wind, solar, hydropower, and biomass projects. "Through a comparatively small investment by the U.S. government, we can ensure that U.S. investors can make low-risk investments that deliver high-reward for the people of India," said Ben Hubbard, the director of USAID's Development Credit Authority.

But while the sector offers ample opportunities for investment, the reality is that building clean energy infrastructure in India is often rife with risks and challenges.

In India, as around the globe, one of the most prominent issues is attracting financing. Global investment in clean energy declined in both 2012 and 2013, and India has not been immune to the trend. Investments in India's clean energy sector fell by 27 percent in 2012 to $7.6 billion, and spending improved only marginally in 2013 to $7.8 billion, buoyed by a fourth-quarter pick-up after declining all year. The figures suggest that U.S. policymakers may need to temper their expectations for fundraising in the sector.

As in other emerging markets, doing businesses in India exposes companies to a complex set of risks. Risks from political decisions and events loom large; they may become even more consequential if India's upcoming national elections produce a weak governing coalition and resulting political instability, as many fear.

The powerful effect that politics can have on the financial stability of energy projects was illustrated last July, when Gujarat, one of the biggest solar power-producing states, asked for retroactive cuts to solar subsidies after realizing that the program burdened the state budget but delivered higher-than-expected profits to developers. Had this move succeeded, it would have threatened returns and the ability of plants to pay their lenders. In another instance, Rajasthan, India's largest wind farm market, withdrew tenders for wind-farm licenses after a lobbying group and a developer opposed to the auction filed complaints in court. As a result, India has yet to complete its first-ever wind auction.

Local opposition to projects can also serve a fatal blow. India's central government recently blocked the Vendata Odisha mines project, after local tribes who believe their gods dwell in the hills where mining activities were planned voiced their opposition. In 2005, Enron's multi-billion dollar Dabhol power plant project was shut down after local activists and the state government turned against it.  

Regulatory uncertainty also poses difficulties for foreign investors. India's worsening business climate caused the country to fall to 134th out of 189 countries on the 2014 Doing Business Index. The country scored especially low on indicators such as dealing with construction permits and enforcing contracts. The risks inherent in India's lax contract enforcement were most obvious last year, when the renewable energy certificate market nearly collapsed as regulatory authorities failed to enforce the renewable purchase obligations of Indian power companies. The sector is now also faced with regulations requiring significant use of locally manufactured solar panels and cells, which are often more expensive and of poorer quality than imported products. Just last week, the U.S. launched a complaint against these practices at the WTO.

India's ubiquitous corruption problem, reflected in its low Corruption Perception Index score, is an added challenge. Indian firms in the infrastructure industry rate corruption, bribery and fraud as among their top risks. Multinational corporations in India frequently complain that the multiple levels of bureaucracy involved in getting licenses and the opaqueness of the process introduce a chance of being exposed to corrupt practices, which can lead to costly legal battles and losses in reputation and earnings. Foreign companies such as Siemens, Wal-Mart, Kraft Foods and Oracle have already been caught up in such costly scandals.

Finally, in the near-term at least, currency will present an additional risk for foreign investors. Following incredible volatility in 2012, the value of the Indian rupee plunged by roughly 23 percent in August 2013, earning a place among what are now termed the "Fragile Five" currencies. A widening current account deficit and persistently high inflation have worsened India's monetary challenge. In late January, the value of the rupee began falling again on speculation that the U.S. Federal Reserve would begin winding down its stimulus, forcing the Reserve Bank of India to raise interest rates. Given limits to what monetary tightening can achieve in a slowing economy, the rupee will likely remain under pressure in the foreseeable future - introducing yet another source of risk for investors.

Outwardly, the various incentives offered by the Indian and American governments may make India's clean energy sector look attractive to foreign investment. Yet helping India's clean energy sector grow will be a difficult process. Global clean energy investments continue to fall around the world, and investors entering India's clean energy market are likely to face political, regulatory, due diligence and macroeconomic risks that can jeopardize their businesses and deter future investments.

The success of the current U.S. efforts to channel capital to the Indian clean energy sector will hinge on setting achievable targets for raising capital, and developing strategies to help investors mitigate the laundry list of risks they face. Ignoring these challenges or minimizing the threats may prove to be disastrous - both for U.S. policy and the development of India's alternative energy sector.

Shehzad H. Qazi is a fellow at the Institute for Social Policy and Understanding and a pollster working in emerging markets. Follow him on Twitter at @shehzadhqazi

Nicholas Shiya is a senior associate at KPMG's Major Projects Advisory Practice.