In the race to fully energize India, renewables are beating coal.

That is one of the most surprising findings in the new report Financing India’s Clean Energy Transition, which was researched and written by Bloomberg New Energy Finance with support from the David and Lucile Packard Foundation. According to the report, released earlier this month, renewable capacity (not including large hydro) is being added at a quicker clip in India than that of its dirty competitor. In fact, renewables have posted a cumulative compound annual growth rate of 15 percent, compared to 12.5 percent for coal power plants between fiscal years 2013 and 2016.

In some respects, the rapid deployment of clean energy in India -- particularly solar, which is besting wind and other renewables -- shouldn’t be a huge surprise. After all, India’s clean energy goals are so ambitious that fast growth is absolutely necessary if the nation has any chance of achieving them. Indeed, Prime Minister Narendra Modi’s government has targeted the construction of 175 gigawatts of renewable energy by 2022. In addition, the government has mandated the rapid electrification of more than 18,000 villages. At the end of fiscal year 2016, India had a total of 42.6 gigawatts of installed clean energy capacity, which amounts to 14 percent of the country’s overall generation capacity.

Ambitious targets that provide over 300 million people the many benefits that come from reliable access to clean electricity is clearly an important starting point. But as the report’s authors point out, there are important challenges to overcome, particularly around financing this clean energy revolution, which is estimated to represent a $150 billion investment opportunity. While government policy is vital for India to reach its clean energy goals, the country’s financial markets and outside investors will need to play a major role.

Financial challenges and opportunities

To untangle the financing challenges and opportunities in India, the report’s authors divided the clean energy sector into four distinct categories: utility-scale projects, which are defined as 1 megawatt and larger; small and rooftop solar, defined as ranging between 1 kilowatt and 1 megawatt in size; small energy grids between 100 watts and 50 kilowatts; and solar home systems and lanterns 100 watts and smaller. Some of the issues raised by the report in each category are outlined below.

Utility-scale projects

Put simply, large clean energy installations are already being financed and built in India at a fairly rapid pace. Driven largely by the government’s goal to install 175 gigawatts by 2022, investments have flowed in from foreign and domestic sources to support construction. The report’s authors note that asset financing has grown by nearly $4 billion -- from $6.6 billion to $10.5 billion -- between fiscal years 2014 and 2016. Despite that vigorous level of activity, the financing required in the years ahead is substantial.

The report’s authors believe it will require a total of $100 billion in asset finance, including $30 billion in equity capital, between 2016 and 2022 for India to reach its target of 135 gigawatts of installed utility-scale projects. The financing challenges involved with reaching this goal include the fact that India has the highest cost of capital in the Asia-Pacific region. Reducing those costs will be critical in order to encourage the scale of investments necessary. Also important, particularly to foreign investors, is improving the ease of doing business in India. Domestically, policy changes and innovations that make it easier for institutional investors to back renewable energy are important.

Already, there is some important movement to scale up the required investment, including the use of green bonds to raise debt and refinance projects. The report’s authors also note that infrastructure investment trusts -- a version of the YieldCos used in the U.S. market -- are advancing as well. “The idea is that investor interest is protected and developers can quickly recycle equity in large commissioned projects by selling it to long-term institutional and retail investors seeking lower, but stable, returns,” wrote the authors. “These structures have started to attract increased interest after a series of regulatory amendments made them more palatable, and could be crucial for the estimated $30 billion equity that the utility-scale projects need.”

Small and rooftop solar

Only a few years ago, there was essentially no small and rooftop solar development in India whatsoever. But demand from commercial and industrial customers has led to an annual CAGR of 92 percent over the past four years and cumulative installations of 500 megawatts. This rapid deployment has a straightforward explanation: compelling economics. Commercial and industrial customers that have sufficient cash have embraced solar as a replacement for expensive diesel generators many use for backup power in places where grid-tied electricity is spotty. The short payback time that comes with making the switch to solar has been the primary driver of small and rooftop solar, although the implementation of net metering in most Indian states could also contribute to more installations.

But in order to reach the government’s 40-gigawatt solar target, India will have to have a cumulative CAGR of 108 percent over the next six years. Unlocking third-party financing will be critical, as will an overall maturation of a financing industry able to meet the demand for small and rooftop solar. There is some movement in this direction, the report’s authors say.

“Various international agencies are committing new funding for the small solar segment to their partner banks/non-banking financial companies in India,” according to the report. “The following steps can go a long way toward ensuring further growth in the sector: educating long disbursement agencies and creating standardized loan application review processes; establishing and propagating norms for quality controls of products; pilot studies to measure the technical and commercial impact of high penetration of rooftop solar on host power distribution companies; creating intermediation platforms to raise awareness and reduce transaction costs; and time-bound clearance of subsidy applications.”

Small energy grids

The Indian government has made it a priority to provide electricity to the 73 million rural households that either have no connection to the power grid or are not reliably served by it. According to the report, small energy grids (SEGs) -- most of them based on solar PV -- are now being used by 75,000 households. Installations in fiscal year 2016 were nearly 300 percent higher than in 2013, albeit from a small starting point. Financing for small energy grids is both haphazard and at a relatively miniscule level.

According to the report, the 11 companies pursuing small-grid development raised $16 million in equity and $6.26 in debt finance between fiscal year 2013 and 2016. “Financing for the SEG segment happens in fits and starts and is tied to the fortunes of a small number of companies,” the authors wrote. “Bank loans, venture capital and private equity, occasional funds from corporate social responsibility mandates, and crowdfunding are all being tapped as sources.”

One important change that needs to take place in order for small grid financing to increase and become more systematic is policy certainty about what happens when the grid is extended somewhere an SEG has been established. The worry investors in SEGs have is that competition from grid-supplied electricity will strand their investment. Addressing that question through policy can help.

Solar home systems and lanterns

According to the report’s authors, around 5.5 million lanterns and solar home systems have been sold in India. The sector’s growth potential, however, is limited by a number of factors, including a lack of access to financing for solar kit companies, because banks and investors consider the industry too high-risk. The report’s authors highlight ways the sector can grow in a more robust way.

“As the market grows, new models like pay-as-you-go are gaining ground,” they wrote, also noting that the Reserve Bank of India has taken steps to increase banking services in rural, underserved areas. “Besides this, a unified payment interface has been launched that will allow money transfer from a bank account to different merchants, both online and offline, without the hassle of typing in credit card details.”