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A case study for sustainable development action using financial gradients
Energy Policy 47 (2012) 79–86
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A case study for sustainable development action using financial gradients Arnab Bose n, Aditya Ramji, Jarnail Singh, Dhairya Dholakia The Energy and Resources Institute, IHC Complex, Lodhi Road, New Delhi 110003, India
a r t i c l e i n f o
abstract
Article history: Received 7 December 2011 Accepted 14 March 2012 Available online 4 April 2012
Energy access is critical for sustainable development and therefore financing energy access is a necessity. The key is whether to focus on grants or public finance for sustainable development projects or move to a more diffused financing mechanism, involving investment grade financing sources like debt and equity. In other words, financing sustainable development action via grants is becoming a constraint. To address this constraint, it is important to consider the relationship between the nature and sources of financial flows. The concept of ‘financial gradients’ emerged while analysing the financial and business strategy developed for Lighting a Billion Lives (LaBL) campaign. This paper espouses the idea of ‘financial gradients’ which is a potential financial mechanism for sustainable development action. Financial gradients, can contribute in three different ways—first, as an approach to analyse financial flows in projects; second, as a tool to generate a single, long term and stable inflow of finance; third, as a financial mechanism to help in creating long term strategies to sustain projects. This paper will concentrate on financial gradients as a potential approach to analyse financial flows in a sustainable development programme. & 2012 Elsevier Ltd. All rights reserved.
Keywords: Sustainable development Financial gradients Sources of finance
1. Introduction Since the formulation of Agenda 21 (a global agenda for transition to sustainability in the 21st century agreed to at the 1992 Earth Summit (UNCED), at Rio de Janeiro) in 1992, adopting a development path based on the principles of sustainable development has become an aspiration for countries across the world. The concept of sustainable development is relevant in principle to all countries or societies, whether they are developing or developed. To achieve sustainable development goals, many countries have initiated strategies including programmes at local, regional, and national levels (Biermann, 2010). Climate change is a phenomenon with pervasive and far-reaching social, economic, environmental, and political repercussions. The assessment by the Intergovernmental Panel on Climate Change (IPCC) and other analyses have brought forth the potential negative impacts for poverty alleviation efforts, which threaten to undo many of the development gains achieved in recent times. Climate change has the potential to undermine the existence of many of the world’s poorest and most vulnerable people, who lack the financial, technical, human and institutional resources to adapt.
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Corresponding author. Tel.: þ91 11 2468 2100; fax: þ91 11 2468 2144. E-mail addresses: [email protected] (A. Bose), [email protected] (A. Ramji). 0301-4215/$ - see front matter & 2012 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.enpol.2012.03.038
So far, the course of action across the globe has been a wide spread of both mitigation and adaptation strategies. However, much can be done to turn the challenge of climate change into opportunities for sustainable development. By promoting clean energy technologies and sound tropical forestry, we can involve the poor in an urgent global effort to mitigate greenhouse gas emissions, such that it leads to improved livelihoods, while reducing climate vulnerability (Fankhauser and Burton, 2011; Eriksen et al., 2011). The paradigm of sustainable development reflects a consensual shift, from a singular focus on economic growth to a concept of socio-economic development, that is, ‘‘modified to take into account its ultimate dependence on the natural environment’’. After several decades of effort and thought, the concept has evolved to explicitly comprise three overwhelming concerns for human welfare—economic, social, and environmental—as well as the inter-dependencies and inter-linkages between them (Harvey and Pilgrim, 2011). The current situation suggests that a major departure has to be made from the past pattern of development. It is also true, that for a developing country like India, promoting economic growth and development will continue to remain a primary goal. Therefore, it is crucial here to understand the need to achieve future development that is economically viable, socially equitable, environmentally sustainable, and most importantly, ethically acceptable (Heyd, 2010). India’s development goals are quite complex. With a considerable rural population, there is a greater need for programmes to
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address the synergy between sustainable development and climate change. Some of them include programmes for biodiversity protection, energy security, diversification of agriculture and rural livelihoods among many others. While there is an urgent need to adopt a multi-pronged strategy to prepare for sustainable development pathways—energy efficiency and mainstreaming of renewable sources into the country’s energy mix are indispensable in order to achieve its developmental objectives. Energy access is critical for achieving our development objectives. If all these programmes are to deliver the objectives of sustainable economic growth and social progress, it would require a large amount of financial support. Financial stability is a key challenge for the implementation of such programmes. In the context of financial needs, a commitment of $100 bn was agreed upon in the Copenhagen Accords for climate change adaptation and mitigation in developing countries. This sum is roughly equivalent to the total current global flows of Official Development Assistance (ODA). Climate change thus presents a significant additional challenge that requires resources equal to ODA. It is not as simple as just ‘slotting in’ climate finance obligations into ODA budgets. Alongside the commitment to mobilise annual climate finance reaching $100 billion per year by 2020, in the Copenhagen Accords developed countries also committed to collectively mobilise $30 billion of ‘Fast Start Finance’ between 2010 and 2012 for adaptation in the most vulnerable countries and mitigation in emerging economies. This ‘Fast Start Finance’ was to be made up of existing ODA commitments and intended to cover the period of 3 years in which developed countries can agree and implement their ‘new and additional’ commitments to the $100 billion per year (Burgess, 2011). In the Indian context, the issue of climate change cannot however be taken up without linking it to developmental needs such as poverty, health, energy access and education. Estimates suggest that it will cost US$130 billion simply to ensure that all Indian households enjoy access to electricity by 2030—a cost that would rise if this power were to come from clean fuel sources. Prof. Nicholas Stern has also acknowledged that adverse impacts of climate change on developing countries must be addressed through adaptation measures; that the costs of such measures are also significant and while developed countries do have a responsibility to provide the necessary resources for adaptation, it would be politically infeasible for them to go beyond the Monterrey ODA target of 0.7% GDP. Accordingly, ways must be found of ‘‘harmonising’’ climate change adaptation needs with accomplishments of the Millennium Development Goals (MDGs) with the same resources (Prasad and Koccher, 2009). It is critical to understand that money alone cannot solve the problem. There are large risks associated. Uncertainties can be of various types, for instance, socio-economic uncertainty, e.g. development of different macroeconomic factors; policy uncertainty, e.g. about commitment to specific targets and stability of CO2 prices; scientific uncertainty, e.g. about climate sensitivity, feedback effects, etc.; market uncertainty like fuel price volatility; technological uncertainty e.g. availability of renewable technology (Fuss et al., 2010). We know that given the uncertainties and the scale of financing required, innovation is crucial. Therefore to address the problem, a trend to innovate financial options for sustainable development action has evolved known as ‘Financial Gradients’ (Bose, 2011). There is a simple underlying argument in this paper. The problems faced for financing sustainable development action across the globe were also the problems faced by a programme for Energy Access using Renewable Energy (more details in the case study below). A financial gradient understanding was
developed during the analysis of the programme, which can be very helpful in three ways. First, as an approach to analyse financial flows in programmes or projects in the sustainable development space—it can come up with key financial indicators which can point towards the health of the programme or project. Financial gradients can also act as a tool by which individually volatile sources of finance can be combined together to generate a single long term and stable inflow of finance to fund a programme in sustainable development. Another way to describe Financial Gradients would be as a financial mechanism to help in creating long term strategies with the help of both business and financial models to sustain the programme or project. This paper will focus on financial gradients as an approach in a sustainable development programme.
2. Energy access using renewable energy1 (Palit and Singh, 2011) While renewables have significant potential in contributing to decrease in fossil fuel use and thus make a huge difference to energy security goals, they would also lead to a reduction in environmental impacts. It would also significantly improve livelihoods in rural areas where energy access has been a major hindrance towards the achievement of development goals. Conventionally, the role of renewables has been considered primarily for decentralised applications. The potential of solar thermal energy is very large, varying from megawatt level solar thermal power plants to domestic appliances such as solar cooker, solar water heater and PV lantern. Lighting a Billion Lives (LaBL) campaign is an initiative by TERI that has evolved as an innovative renting model for providing access to clean lighting through solar lanterns. The campaign launched in the year 2008 aims to bring light into the lives of one billion rural people by displacing kerosene and paraffin lanterns with cleaner and efficient solar lighting devices, thereby facilitating education of children; providing better illumination and kerosene smoke-free indoor environment for women to do household chores; and providing opportunities for livelihoods both at the individual and at village level. LaBL operates on fee-for-service or rental model wherein centralised Solar Charging Stations (SCS) are set up in villages for charging the lanterns which are provided daily on rent to households and enterprises. A typical solar lantern charging station consists of 50 solar lanterns with five solar panels and junction boxes. The charging stations are operated and managed by entrepreneurs belonging to the local community (Self Help Groups/ individual youths) who qualify the selection criteria set as part of the LaBL campaign. These entrepreneurs are selected and provided handheld support by local LaBL implementation partners, each of whom is called a ‘LaBL Partner Organisation’ (LaBL-PO). The rent is collected by the entrepreneur, a part of which is used for O&M of the charging station and for replacement of battery as may be required after 18–24 months of operation. So far, TERI has successfully extended the initiative in around 900 villages spanning 17 states in India, impacting more than 240,000 lives. Be it lighting or livelihood generation, the LaBL initiative has successfully demonstrated in India how solar lanterns could impact the community at both the household and village level. The impact of the initiative is not simply the provision of lighting purely in a physical sense, but it has turned to be an instrument which transforms lives and generates hopes and aspirations that clearly enhance human welfare substantially. 1
TERI internal documents.
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There is a direct livelihood benefit in the form of ‘green jobs’ for the entrepreneurs managing the SCS and earning through renting out the solar lanterns. The operators—more than 15% of whom are women—earn approximately INR 2000–3500 per month by renting out solar lanterns. At the household level, the programme has been instrumental in encouraging children—particularly, the girl child, who is usually busy during the day with household activities—in opting for longer study hours. Apart from inducing a smoke-free indoor environment for women, there is improved mobility and safety after dusk for both women and the elderly. In addition, the programme is also advantageous to those who are using the lanterns to earn a living by way of weaving, sewing, vending, running tuition centres, and by providing other village level services. The choice of suitable technology for a particular area would depend upon the availability of resources, the consumption pattern of consumers and degree of dispersion of the population. If it is a highly dispersed population and the main use of electricity is only for the purpose of lighting, then stand-alone systems based on solar are most suitable while for concentrated populations with some productive load, village mini grids are more appropriate. Also, many communities residing in rural areas, particularly in the remote areas, may indicate a visible need for electricity, but this may not necessarily mean the ability to pay for the service. Many a times, the residents in these areas have low levels as well as irregular streams of income. Though, the scarcity of a service, in this context, electricity, may seem an exciting market opportunity for an investor or entrepreneur, the lack of capability to pay or demand in the open market combined with the need for power plants to maintain a certain load factor so as to not operate in loss, underscores the need for careful demand estimation while selecting target villages. The LaBL model has been successful as it conducts a scoping survey to estimate the likely demand for lighting and ability to pay and sizes the plant/operation accordingly. Financing is a key challenge for a solar PV programme. The financial model under the LaBL initiative attempts to bring together all stakeholders together on one platform. The government, TERI, local NGOs (LaBL Partner Organisation) and the community are all involved, reflective of the Public–Private– People Partnership model. The capital costs for setting up the SCS in remote locations are mainly grant-supported from the LaBL Fund (raised from corporate and government schemes) and cofinanced by the LaBL-PO. For ‘not so remote’ villages, where the villagers have some paying capacity, the operators are provided with the option to set up SCS as their own enterprise either putting in their equity or availing loans (facilitated under LaBL initiative), with part of the SCS cost being subsidised by the LaBL Fund. At this point, it is worth mentioning the work of Michael Porter on creating shared value. Mr. Porter recently mentioned that Corporate Social Responsibility (CSR) has not really worked because ultimately it does not have enough impact; it is not focused on results; it is not scalable; it is not sustainable and therefore we actually have to see if we can move beyond the idea that the role of a business in society is to do CSR. Though it may not directly link to the analysis pursued in this paper, it does have relevance to the underlying theme of the Lighting a Billion Lives (LaBL) programme and the emergence of financial gradients as an application in the domain of sustainable development (Elkington, 2011). Kenneth Galbraith once contended that a business was immune from the corrective processes of markets, as it was governed by competition. Although, if the concept of shared value given by Porter and Kramer was to be applied, competition can be used as a corrective form, governed by the shifting interests of
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society, thus, ensuring that the corporation rethinks the manner in which it creates economic value to remain competitive. Thus, social enterprises and hybrid for-profit frameworks can act as a blueprint for corporations to generate economic value that serves a social purpose, and simultaneously increasing the competitiveness and stakeholder accountability of the organisation, as long as it is fully integrated into the value-chain (The Entrepreneuralist, 2011). Carrying this thought further, Porter and Kramer say that a business can have multiple objectives, rather than having a sole mission, as long as it is fully integrated into its core strategy and is in adherence to the competitive context. Furthermore, a business should be driven not by its adherence to a social cause, but by its ability to identify an opportunity to create shared value; and one should argue that beyond the noble and altruistic notion of societal change, the same should be applied to a social enterprise for it to be sustainable, whatever its mission (Porter and Kramer, 2006). Although social entrepreneurship has without doubt gained momentum, for many, hybrid organisations that consider the balance between societal and economic needs are much less stable, may succumb earlier to mortality, and may face a delicate balancing act between stakeholders, resulting in the subversion of organisational goals in favour of personal goals (Pirson, 2011). The LaBL programme is an example of social entrepreneurship which alongwith business simultaneously aims at achieving societal and developmental goals of improved livelihoods, access to basic energy services, and climate change mitigation, thus focusing on both business sustainability and sustainable development. This paper as Pirson puts it, ‘‘makes an attempt to examine the level of embeddedness between shared value, and the social enterprise, and if these can be complimentary’’. In the context of creating shared value, this paper with the help of financial gradients looks at the financial sustainability of the LaBL programme while the programme simultaneously aims at achieving the goals of sustainable development.
3. The genesis of financial gradients While analysing financial data for Lighting a Billion Lives (LaBL), there was a need to structure the sources of finance. It was noticed that while sources of finance for the corporate sector were well researched and theorized and now an established subject called corporate finance; the same could not be said for the sustainable development sector. It was also seen that not only were the nature of projects differ from the traditional corporate sector, the sources of finance also had differences in terms of ‘nature’: some adhering to conventional norms, while some sources of finance were particular to the sustainable development field and had very different characteristics to any other financial source. Also, sustainable development projects were traditionally thought to be financed only with public finance or grants and aid, however, overtime and certainly in recent times, there was a need to attract other sources. Sometimes it was felt that the nature of the same source was changing as well. For instance, public finance, which primarily consists of government money with fiscal objectives, was becoming more in the nature of soft loans. To sum up the above argument; it can be said that the sources of finance in the sustainable development sector have differences in terms of its nature; plus in the life of the sustainable development action the sources and its nature are dynamic; or the source, nature or both (of finance), change over time. Overall, there is a general tendency or a noticeable trend of the nature of finance in this sector to move away from developmental objectives to an investment category of financing. It was also felt
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Fig. 1. Financial Gradients—the decreasing slope of grant inflows.
that financing of sustainable development projects start with an emphasis on grants; however, if the project has to sustain over long periods of time, then the project should also be financially sustainable. It was noticed that grants were particularly volatile in nature, and in recent times it is increasingly so. There are serious issues the world over with the availability of public finance as a pure expenditure source, with governments wanting to cut down public expenditure, and grants becoming increasingly difficult to avail. Here, we are not saying that the project should be profitable, but merely saying that for the project to continue—there should be sufficient financial inflows to carry on with the project. Once there is a stable and sustainable financial inflow then sustainable development projects will last over a long time say for at least for 25 years or longer. They will have time spans commensurate with major infrastructure projects. However, if the financial backing was being availed only via grants, then it will be difficult to move beyond a three-year time horizon and the project will die an untimely death. In order to avert such a situation, project managers will have to adjust their financial sourcing mechanism, or in other words need to look for a more diffused financial mechanism, where the share of non-grant or non-public finance sources increase. If we view this as a series of yearly bar graphs where the amount of money is on the y-axis and sources on the x-axis, then in the initial years, the slope or gradient will be steep as one transitions from grant participation to say, private equity participation in the project. However, the slope will become more gradual after a few years of the project being in existence. This will be indicative that the project is working well and is attracting investments on its own merits. In general, the diminishing percentage of the grant component is a good sign of the programme, and in Fig. 1 we see precisely that the grant component for the LaBL campaign is decreasing over a period of three years thus indicative of the programme attracting non-grant financial sources including pure investment sources of finance, as we shall see later. Financial gradients can be indicative of the long term viability, sustainability, and acceptability of the project.
4. Financial gradients: a method for financing sustainable development action To develop a financial theory on programmes or projects in the domain of sustainable development is a daunting task. Nonetheless, in this paper, an attempt is made in that direction
following the experience with similar projects in the domain of sustainable development. The recent financial crisis of 2008 has challenged conventional positions in finance. A pertinent conventional view point is elucidated in the Modigliani–Miller proposition (Modigliani and Miller, 1958). It is present in all corporate finance text books, and is considered seminal work in capital structure of the modern corporate. It has served its purpose especially in the corporate sector (Miller, 1988); however, in the wake of the 2008 financial crisis, this proposition has to be understood in a new light—many papers allude to this topic with various entry points; for instance, one looks at it from an entrepreneurial angle (Koch et al., 2010); or from the more holistic viewpoint of mortgages (Ostaszewski, 2009)—the outcome of these papers point towards the premise that the nature and sources of finance are important and crucial from the institutional and extremely important from the governance points of view. The Modigliani–Miller proposition assumes symmetric information and efficient markets. However, given the present scenario, the previous assumptions may not be as valid as originally inferred. An inference can be drawn that the nature and sources of finance play a crucial role in the process of value creation, both at the firm level and more importantly at the institutional level. Another facet of this paper is sustainable development. Sustainable development has evolved over the years, after much deliberation, to include three most crucial aspects of human welfare—economic, social, and environmental—it also includes all common areas between them. Sustainable development has induced a change in thought from a singular focus on economic growth to a more multi-faceted approach. And since the formulation of Agenda 21 in 1992, adopting a development path on the principles of sustainable development has become the goal for a huge majority of countries around the world (Kumar, 2011). Given the new challenges of the financial world and the emergence of the concept of sustainable development, projects and programmes in the domain of sustainable development have to be structured and thought about in a fresh perspective. The method of ‘‘financial gradients’’ is the understanding of the nature and sources of finance. Inherently, a financial commitment is made for a particular purpose; also, the mix of finance in a particular project can guide the results or outcomes, particularly at the institutional level. As we have seen, a seemingly innocuous debt–equity ratio, if not interpreted correctly can cause a global financial crisis. In considering the financial aspects or interactions, the nature of finance with the source of finance are the most important, the change of capital structure over time, the nature of the business model, and so on—all can be considered—but the essence of financial gradients lies in the understanding of these interactions. In other words, there are different aspects or factors in financial theory. These aspects or factors interact with each other, but the most important interactions for ‘financial gradients’ is the interaction between the nature and sources of finance. In each case, the programme or project will have its own story and its own set of priorities, but in the financial sense and especially in the context of sustainable development, the nature and sources of finance are at the core. A case study below will explain this further. There we will see some interesting notions emerging, for example, financing sources like grants, which have low monitoring requirements are actually very expensive, as here the project implementer will have to identify appropriate monitoring mechanisms and pay for it. However, in the case of equity, which has the highest monitoring requirements, as a source of finance it is much less
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expensive, as the equity investor will monitor the project on his or her own self-interest, thus it can be hypothesised that the costs of the project implementer for monitoring is virtually reduced to zero.
5. Financial gradients as an approach Let us recall that financial gradients can be seen as an approach to analyse financial flows in programmes or projects in the sustainable development space. It can develop indicators to assess the health of the project. We can infer that the health of the project is good if the key challenges are met while the project is running. Financial gradients as an approach is described below as a case study for a project in the sustainable development field in the initial years of its activity. 5.1. Case study (All details in terms of data analysis and figures given here are only for exposition. The case study has been developed with the help of the data available from TERI’s Lighting a Billion Lives&a initiative. For further details on the LaBL initiative, refer to the web site http://labl.teriin.org). The key challenges will be addressed and then the analysis will follow using financial gradients approach. The key financial challenge to implement projects in the sustainable development space is to secure long-term, stable finances. This challenge can be broken down to two parts (particularly for non-governmental implementation of projects). First, how does the project diversify the sources of funds; and, second, how does the project scale up funds from all the sources. Given these challenges, it can be said that a programme or project in the sustainable development space has attained credibility in terms of its financial and business models, if there are positive trends in two key financial indicators. First, the overall financial inflows have to increase from all sources—this is particularly true when a project has just started and scaling up is an inherent programme-level requirement. Second, over time the sources of finance should be diversified. Therefore, over time the percentage share from different sources should trend towards a more equal distribution. The project used to describe financial gradients as an approach is Lighting a Billion Lives and is referred to as LaBL hereafter. The period of analysis is from 2008–09 to 2010–11. LaBL funds have been generated through a range of financial instruments, which largely include grants, but also equity investments, loans, syndication, payment for services, research grants, and so on. Apart from the two key challenges, there are a wide variety of questions, which came up and a few relevant ones are given below:
How can the financial flows for the LaBL campaign be analysed
and trends interpreted? J Is there an increase in the volume of financial inflows in the project? J Is there diversification in terms of the sources of finance? Do the trends show progress in financial viability and sustainability of the business model developed by LaBL? To what extent is LaBL leveraging private finance? What is the nature and quantum of public finance being leveraged by LaBL?
To answer the above questions, financial gradients as an approach will be put to use. Now, using the financial gradients methodology, capital ‘‘inflow’’ for the LaBL project will be analysed. For the purpose
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of this analysis, two schemes of classification have been created viz. Sources and Nature. Source identifies the entity providing the fund, while Nature gives us the information about the characteristics of the financial inflow, whether it is equity, debt, public finance or grant, and what kind of tax or other kinds of financial implications are attached to them. All inflow transactions were analysed and clubbed together in different categories within the classes. These were created keeping in mind the sources and nature of the fund. Table 1 will give out the details of each category. The categories were created such that each one is mutually exclusive of the other. Table 2 indicates the nature of financing. Again, the categories have been created such that they are mutually exclusive and give us a clear indication of the evolution of the pattern of financing in LaBL. Table 3 sums up the nature of finance with respect to monitoring requirements very specific to the LaBL programme. Two points to note are as follows. Lower monitoring requirements essentially mean that the cost of monitoring will be much higher. This is because financing sources like grants which have low monitoring requirements are actually very expensive—as here the project implementer will have to figure out monitoring mechanisms and pay for it. However, in case of equity, which has the highest monitoring requirements, as a source of finance is much less expensive, as the equity investor will monitor the project on his or her own selfinterest, thus it can be hypothesised that the costs of the project implementer for monitoring requirement is virtually reduced to zero. One point of information is that a research grant should be interpreted as equity, as the output of the research grant can potentially be monetized and returns can be earned as a result of that. Keeping this in mind then equity and research grant both should constitute equity. 5.2. Case study analysis The bar charts represented in Figs. 2–4, help us understand the financial trends observed in the nature of funds received by LaBL for the three financial years being analysed. From the bar charts, it
Table 1 Sources of LaBL finance. S.No
Source of LaBL finance
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Bilaterals Multilaterals Events Registration charges Co-funding Government Corporate social responsibility Institutional social responsibility Individuals Payment for services
Table 2 Nature of LaBL finance. S.No
Nature of LaBL finance
1. 2. 3. 4. 5.
Pure grant Research grant Loans (soft or otherwise) Equity (including co-funding) Public expenditure
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Table 3 Nature of finance and monitoring requirements. Category
Definition
Monitoring requirement
Pure grant Research grant Public expenditure/subsidy Loans Equity
Funds given as a part of philanthropic activity or partly with an intention to claim tax exemption Funds given with a research objective and a tangible outcome is expected (a report, a product etc.) Government funds with fiscal objectives Funds provided by a bank with a ToR similar to retail lending User/community/entrepreneur contribution towards the project hardware cost
Negligible Low Medium High Highest
Fig. 5. Inflow in Indian Rupees (INR) from 2008–09 to 2010–11.
Fig. 2. Financial Inflows for the year 2008–09.
Fig. 3. Financial Inflows for the year 2009–10.
Fig. 4. Financial Inflows for the year 2010–11.
can be inferred that there is a movement from a pure grant-based method of financing to a more community or private equitybased method of financing. This equity-driven model will get further impetus when there are more lines of business, like provisions for charging for mobile telephony in addition to charging solar lanterns, are attached to the core model. There are various possibilities of increasing lines of businesses; however, the charts below for the first three years are purely for solar lanterns as the only line of business. It can be seen from the bar charts that in the first year of LaBL’s operation, there was no equity component. This then rises to 1% in the second year and then to 7% in the third year. We also see that the pure grant component is decreasing rapidly from an ominous 91% in the first year to 81% in the second, and a far more viable 66% in the third year. If we add the research grant to pure equity, we find that the equity component is doing very well, from a 7% in the first year to 16% in the second year, and finally a very promising 27% in the third year. Overall, the non-grant finances are rising fast from 9% to 19% and then to 34% in the final year. We should remember that this strong performance in building a sustainable financial model was built with only one line of business; the charging stations have the potential to stand alone as a viable business without any grant component in the future when more lines of businesses are included. Also, we must note that here we have talked in terms of percentages, we must bear in mind that in absolute numbers (or amount of money being allocated for LaBL) there has been huge increase across all categories. The picture above is surely a cheerful picture for ‘sustainable’ business models in ‘‘real life’’. In Fig. 5, we can see that there was an overall increase in financial inflows from year to year, and also we can see that each individual component also saw an increase in magnitude of financial inflows. The analysis so far outlines two gradients as key—one, an increase in total finance which is an indication of scaling up of efforts as funds are invested towards workable solutions and second, decrease in non-investment category finance, particularly grants, as a percentage of total finance.
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Fig. 6. Project Costs over time in Indian Rupees (INR) from 2008–09 to 2015 (projected).
A third kind of gradient that would be essential to assess the sustainability of projects in the domain of sustainable development would be to see the financial help (mostly government subsidy or grant) per beneficiary decrease as scaled up efforts reach economies of scale and a decrease in the risk capital required to broaden the domain of activities within the projects. Fig. 6 captures this aspect. We can see that with time as efforts are scaled up the project costs reduce significantly and will reduce further as the outreach and domain of activities under the programme increase.
mechanism prevalent in the sustainable development and climate action space. However, much more research needs to be done and many case studies applying the financial gradients method needs to be carried out to make financial gradients a robust and implementable concept.
Appendix A. Supporting information Supplementary data associated with this article can be found in the online version at doi:10.1016/j.enpol.2012.03.038.
5.3. Case study conclusion There is a clear trend that the grant component is decreasing and the equity component, both pure and in other forms, is increasing. We also see that the total funding across all components is increasing as well. This definitely augurs well for the LaBL finance models. There is a clear trend that LaBL finance is moving from a pure grant-driven financial model to a more flexible model where private or investment category financing mechanisms are playing larger roles. We can also see that the two key indicators, one of scaling up financial inflows, and second, of achieving diversification from the point of view of sources of finance was also achieved.
6. Summary In this paper, we have addressed the central debate in sustainable development finance, and noted that sustainable development action needs to attract investment-grade financing sources. The paper notes that sustainable development action and climate action have a common goal and financing both has a common problem. The key is to understand both—the nature and sources of financial inflows as well as the synergy between them. To address this problem, the concept of ‘‘financial gradients’’ has been developed. ‘Financial gradients’ is a method of understanding financial flows in relation to the nature and sources of these flows. It can give us an indication of the health of a sustainable development programme. The case study in this paper reflects that it has the potential to develop better understanding of the financial
References Biermann, F., 2010. Beyond the intergovernmental regime: recent trends in global carbon governance. Current Opinion in Environmental Sustainability 2 (4), 284–288. Bose, A., 2011. Climate Finance and Financial Gradients: perspectives and methods. International Journal of Regulation and Governance 11 (2). Burgess, J., 2011. The $100 Billion Question: How do Secure a Climate-resilient Future for the World’s Children?, United Kingdom. UNICEF. Elkington, J., 2011. Don’t abandon CSR for Creating Shared Value Just Yet. The Guardian, 25th May, 2011. /http://www.guardian.co.uk/sustainable-business/ sustainability-with-john-elkington/corporate-social-resposibility-creatingshared-valueS (accessed on 05.03.12). Eriksen, S., Aldunce, P., Bahinipati, C.S., Martins, R.D., Molefe, J.I., Nhemachena, C., O’ Brien, K., Olorunfemi, F., Park, J., Sygna, L., Ulsrud, K., 2011. When not every response to climate change is a good one: identifying principles for sustainable adaptation. Climate and Development 3 (2011), 7–20. Fankhauser, S., Burton, I., 2011. Spending Adaptation Money Wisely. Centre for Climate Change Economics and Policy Working Paper No. 47 and Grantham Research Institute on Climate Change and the Environment Working Paper No. 37. Fuss, S., Szolgayova, J., Khabarov, N., Obersteiner, M., 2010. Renewables and climate change mitigation: irreversible energy investment under uncertainty and portfolio effects. Energy Policy. Harvey, M., Pilgrim, S., 2011. The new competition for land: food, energy, and climate change. Food Policy 36 (1), S40–S51. Heyd, T., 2010. Climate change, individual responsibilities and cultural frameworks. Human Ecology Review 17 (2), 86–95. Kumar, A., 2011. Growth, Sustainable Development and Climate Change: Friends or Foes? Inaugural Address as Professor to the Prince Claus Chair in Development and Equity 2010–2012. Utrecht University. Miller, M.H., 1988. The Modigliani–Miller propositions after thirty years. Journal of Economic Perspectives 2 (4), 99–120. (fall 1988). Modigliani, F., Miller, M.H., 1958. The cost of capital, corporation finance and theory of investment. American Economic Review 48 (3), 261–297. (June 1958). Ostaszewski, K., 2009. Modigliani, Miller and Mortgages. Society of Actuaries.
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Palit, D., Singh, J., 2011. Lighting a billion lives—empowering the rural poor. Boiling Point, 59. Pirson, M., 2011. Social Entrepreneurs as the Paragons of Shared Value Creation? A Critical Perspective. Fordham University Schools of Business; Harvard University, Massachussets. Porter, M.E., Kramer, M.R., 2006. Strategy and society: between competitive advanatage and corporate social responsibility. Harvard Business Review, 78–94.
Prasad, H.A.C., Koccher, J.S., 2009. Climate Change and India—Some Major Issues and Policy Implications. Department of Economic Affairs, Ministry of Finance, Government of India. The Entrepreneuralist, 2011. The Hybrid Social Enterprise and Shared Value: The Future of Business. /http://theentrepreneurialist.net/2011/02/07/the-hy brid-social-enterprise-and-shared-value-the-future-of-business/S (accessed on 05.03.12).
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Energy Policy journal homepage: www.elsevier.com/locate/enpol
A case study for sustainable development action using financial gradients Arnab Bose n, Aditya Ramji, Jarnail Singh, Dhairya Dholakia The Energy and Resources Institute, IHC Complex, Lodhi Road, New Delhi 110003, India
a r t i c l e i n f o
abstract
Article history: Received 7 December 2011 Accepted 14 March 2012 Available online 4 April 2012
Energy access is critical for sustainable development and therefore financing energy access is a necessity. The key is whether to focus on grants or public finance for sustainable development projects or move to a more diffused financing mechanism, involving investment grade financing sources like debt and equity. In other words, financing sustainable development action via grants is becoming a constraint. To address this constraint, it is important to consider the relationship between the nature and sources of financial flows. The concept of ‘financial gradients’ emerged while analysing the financial and business strategy developed for Lighting a Billion Lives (LaBL) campaign. This paper espouses the idea of ‘financial gradients’ which is a potential financial mechanism for sustainable development action. Financial gradients, can contribute in three different ways—first, as an approach to analyse financial flows in projects; second, as a tool to generate a single, long term and stable inflow of finance; third, as a financial mechanism to help in creating long term strategies to sustain projects. This paper will concentrate on financial gradients as a potential approach to analyse financial flows in a sustainable development programme. & 2012 Elsevier Ltd. All rights reserved.
Keywords: Sustainable development Financial gradients Sources of finance
1. Introduction Since the formulation of Agenda 21 (a global agenda for transition to sustainability in the 21st century agreed to at the 1992 Earth Summit (UNCED), at Rio de Janeiro) in 1992, adopting a development path based on the principles of sustainable development has become an aspiration for countries across the world. The concept of sustainable development is relevant in principle to all countries or societies, whether they are developing or developed. To achieve sustainable development goals, many countries have initiated strategies including programmes at local, regional, and national levels (Biermann, 2010). Climate change is a phenomenon with pervasive and far-reaching social, economic, environmental, and political repercussions. The assessment by the Intergovernmental Panel on Climate Change (IPCC) and other analyses have brought forth the potential negative impacts for poverty alleviation efforts, which threaten to undo many of the development gains achieved in recent times. Climate change has the potential to undermine the existence of many of the world’s poorest and most vulnerable people, who lack the financial, technical, human and institutional resources to adapt.
n
Corresponding author. Tel.: þ91 11 2468 2100; fax: þ91 11 2468 2144. E-mail addresses: [email protected] (A. Bose), [email protected] (A. Ramji). 0301-4215/$ - see front matter & 2012 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.enpol.2012.03.038
So far, the course of action across the globe has been a wide spread of both mitigation and adaptation strategies. However, much can be done to turn the challenge of climate change into opportunities for sustainable development. By promoting clean energy technologies and sound tropical forestry, we can involve the poor in an urgent global effort to mitigate greenhouse gas emissions, such that it leads to improved livelihoods, while reducing climate vulnerability (Fankhauser and Burton, 2011; Eriksen et al., 2011). The paradigm of sustainable development reflects a consensual shift, from a singular focus on economic growth to a concept of socio-economic development, that is, ‘‘modified to take into account its ultimate dependence on the natural environment’’. After several decades of effort and thought, the concept has evolved to explicitly comprise three overwhelming concerns for human welfare—economic, social, and environmental—as well as the inter-dependencies and inter-linkages between them (Harvey and Pilgrim, 2011). The current situation suggests that a major departure has to be made from the past pattern of development. It is also true, that for a developing country like India, promoting economic growth and development will continue to remain a primary goal. Therefore, it is crucial here to understand the need to achieve future development that is economically viable, socially equitable, environmentally sustainable, and most importantly, ethically acceptable (Heyd, 2010). India’s development goals are quite complex. With a considerable rural population, there is a greater need for programmes to
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address the synergy between sustainable development and climate change. Some of them include programmes for biodiversity protection, energy security, diversification of agriculture and rural livelihoods among many others. While there is an urgent need to adopt a multi-pronged strategy to prepare for sustainable development pathways—energy efficiency and mainstreaming of renewable sources into the country’s energy mix are indispensable in order to achieve its developmental objectives. Energy access is critical for achieving our development objectives. If all these programmes are to deliver the objectives of sustainable economic growth and social progress, it would require a large amount of financial support. Financial stability is a key challenge for the implementation of such programmes. In the context of financial needs, a commitment of $100 bn was agreed upon in the Copenhagen Accords for climate change adaptation and mitigation in developing countries. This sum is roughly equivalent to the total current global flows of Official Development Assistance (ODA). Climate change thus presents a significant additional challenge that requires resources equal to ODA. It is not as simple as just ‘slotting in’ climate finance obligations into ODA budgets. Alongside the commitment to mobilise annual climate finance reaching $100 billion per year by 2020, in the Copenhagen Accords developed countries also committed to collectively mobilise $30 billion of ‘Fast Start Finance’ between 2010 and 2012 for adaptation in the most vulnerable countries and mitigation in emerging economies. This ‘Fast Start Finance’ was to be made up of existing ODA commitments and intended to cover the period of 3 years in which developed countries can agree and implement their ‘new and additional’ commitments to the $100 billion per year (Burgess, 2011). In the Indian context, the issue of climate change cannot however be taken up without linking it to developmental needs such as poverty, health, energy access and education. Estimates suggest that it will cost US$130 billion simply to ensure that all Indian households enjoy access to electricity by 2030—a cost that would rise if this power were to come from clean fuel sources. Prof. Nicholas Stern has also acknowledged that adverse impacts of climate change on developing countries must be addressed through adaptation measures; that the costs of such measures are also significant and while developed countries do have a responsibility to provide the necessary resources for adaptation, it would be politically infeasible for them to go beyond the Monterrey ODA target of 0.7% GDP. Accordingly, ways must be found of ‘‘harmonising’’ climate change adaptation needs with accomplishments of the Millennium Development Goals (MDGs) with the same resources (Prasad and Koccher, 2009). It is critical to understand that money alone cannot solve the problem. There are large risks associated. Uncertainties can be of various types, for instance, socio-economic uncertainty, e.g. development of different macroeconomic factors; policy uncertainty, e.g. about commitment to specific targets and stability of CO2 prices; scientific uncertainty, e.g. about climate sensitivity, feedback effects, etc.; market uncertainty like fuel price volatility; technological uncertainty e.g. availability of renewable technology (Fuss et al., 2010). We know that given the uncertainties and the scale of financing required, innovation is crucial. Therefore to address the problem, a trend to innovate financial options for sustainable development action has evolved known as ‘Financial Gradients’ (Bose, 2011). There is a simple underlying argument in this paper. The problems faced for financing sustainable development action across the globe were also the problems faced by a programme for Energy Access using Renewable Energy (more details in the case study below). A financial gradient understanding was
developed during the analysis of the programme, which can be very helpful in three ways. First, as an approach to analyse financial flows in programmes or projects in the sustainable development space—it can come up with key financial indicators which can point towards the health of the programme or project. Financial gradients can also act as a tool by which individually volatile sources of finance can be combined together to generate a single long term and stable inflow of finance to fund a programme in sustainable development. Another way to describe Financial Gradients would be as a financial mechanism to help in creating long term strategies with the help of both business and financial models to sustain the programme or project. This paper will focus on financial gradients as an approach in a sustainable development programme.
2. Energy access using renewable energy1 (Palit and Singh, 2011) While renewables have significant potential in contributing to decrease in fossil fuel use and thus make a huge difference to energy security goals, they would also lead to a reduction in environmental impacts. It would also significantly improve livelihoods in rural areas where energy access has been a major hindrance towards the achievement of development goals. Conventionally, the role of renewables has been considered primarily for decentralised applications. The potential of solar thermal energy is very large, varying from megawatt level solar thermal power plants to domestic appliances such as solar cooker, solar water heater and PV lantern. Lighting a Billion Lives (LaBL) campaign is an initiative by TERI that has evolved as an innovative renting model for providing access to clean lighting through solar lanterns. The campaign launched in the year 2008 aims to bring light into the lives of one billion rural people by displacing kerosene and paraffin lanterns with cleaner and efficient solar lighting devices, thereby facilitating education of children; providing better illumination and kerosene smoke-free indoor environment for women to do household chores; and providing opportunities for livelihoods both at the individual and at village level. LaBL operates on fee-for-service or rental model wherein centralised Solar Charging Stations (SCS) are set up in villages for charging the lanterns which are provided daily on rent to households and enterprises. A typical solar lantern charging station consists of 50 solar lanterns with five solar panels and junction boxes. The charging stations are operated and managed by entrepreneurs belonging to the local community (Self Help Groups/ individual youths) who qualify the selection criteria set as part of the LaBL campaign. These entrepreneurs are selected and provided handheld support by local LaBL implementation partners, each of whom is called a ‘LaBL Partner Organisation’ (LaBL-PO). The rent is collected by the entrepreneur, a part of which is used for O&M of the charging station and for replacement of battery as may be required after 18–24 months of operation. So far, TERI has successfully extended the initiative in around 900 villages spanning 17 states in India, impacting more than 240,000 lives. Be it lighting or livelihood generation, the LaBL initiative has successfully demonstrated in India how solar lanterns could impact the community at both the household and village level. The impact of the initiative is not simply the provision of lighting purely in a physical sense, but it has turned to be an instrument which transforms lives and generates hopes and aspirations that clearly enhance human welfare substantially. 1
TERI internal documents.
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There is a direct livelihood benefit in the form of ‘green jobs’ for the entrepreneurs managing the SCS and earning through renting out the solar lanterns. The operators—more than 15% of whom are women—earn approximately INR 2000–3500 per month by renting out solar lanterns. At the household level, the programme has been instrumental in encouraging children—particularly, the girl child, who is usually busy during the day with household activities—in opting for longer study hours. Apart from inducing a smoke-free indoor environment for women, there is improved mobility and safety after dusk for both women and the elderly. In addition, the programme is also advantageous to those who are using the lanterns to earn a living by way of weaving, sewing, vending, running tuition centres, and by providing other village level services. The choice of suitable technology for a particular area would depend upon the availability of resources, the consumption pattern of consumers and degree of dispersion of the population. If it is a highly dispersed population and the main use of electricity is only for the purpose of lighting, then stand-alone systems based on solar are most suitable while for concentrated populations with some productive load, village mini grids are more appropriate. Also, many communities residing in rural areas, particularly in the remote areas, may indicate a visible need for electricity, but this may not necessarily mean the ability to pay for the service. Many a times, the residents in these areas have low levels as well as irregular streams of income. Though, the scarcity of a service, in this context, electricity, may seem an exciting market opportunity for an investor or entrepreneur, the lack of capability to pay or demand in the open market combined with the need for power plants to maintain a certain load factor so as to not operate in loss, underscores the need for careful demand estimation while selecting target villages. The LaBL model has been successful as it conducts a scoping survey to estimate the likely demand for lighting and ability to pay and sizes the plant/operation accordingly. Financing is a key challenge for a solar PV programme. The financial model under the LaBL initiative attempts to bring together all stakeholders together on one platform. The government, TERI, local NGOs (LaBL Partner Organisation) and the community are all involved, reflective of the Public–Private– People Partnership model. The capital costs for setting up the SCS in remote locations are mainly grant-supported from the LaBL Fund (raised from corporate and government schemes) and cofinanced by the LaBL-PO. For ‘not so remote’ villages, where the villagers have some paying capacity, the operators are provided with the option to set up SCS as their own enterprise either putting in their equity or availing loans (facilitated under LaBL initiative), with part of the SCS cost being subsidised by the LaBL Fund. At this point, it is worth mentioning the work of Michael Porter on creating shared value. Mr. Porter recently mentioned that Corporate Social Responsibility (CSR) has not really worked because ultimately it does not have enough impact; it is not focused on results; it is not scalable; it is not sustainable and therefore we actually have to see if we can move beyond the idea that the role of a business in society is to do CSR. Though it may not directly link to the analysis pursued in this paper, it does have relevance to the underlying theme of the Lighting a Billion Lives (LaBL) programme and the emergence of financial gradients as an application in the domain of sustainable development (Elkington, 2011). Kenneth Galbraith once contended that a business was immune from the corrective processes of markets, as it was governed by competition. Although, if the concept of shared value given by Porter and Kramer was to be applied, competition can be used as a corrective form, governed by the shifting interests of
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society, thus, ensuring that the corporation rethinks the manner in which it creates economic value to remain competitive. Thus, social enterprises and hybrid for-profit frameworks can act as a blueprint for corporations to generate economic value that serves a social purpose, and simultaneously increasing the competitiveness and stakeholder accountability of the organisation, as long as it is fully integrated into the value-chain (The Entrepreneuralist, 2011). Carrying this thought further, Porter and Kramer say that a business can have multiple objectives, rather than having a sole mission, as long as it is fully integrated into its core strategy and is in adherence to the competitive context. Furthermore, a business should be driven not by its adherence to a social cause, but by its ability to identify an opportunity to create shared value; and one should argue that beyond the noble and altruistic notion of societal change, the same should be applied to a social enterprise for it to be sustainable, whatever its mission (Porter and Kramer, 2006). Although social entrepreneurship has without doubt gained momentum, for many, hybrid organisations that consider the balance between societal and economic needs are much less stable, may succumb earlier to mortality, and may face a delicate balancing act between stakeholders, resulting in the subversion of organisational goals in favour of personal goals (Pirson, 2011). The LaBL programme is an example of social entrepreneurship which alongwith business simultaneously aims at achieving societal and developmental goals of improved livelihoods, access to basic energy services, and climate change mitigation, thus focusing on both business sustainability and sustainable development. This paper as Pirson puts it, ‘‘makes an attempt to examine the level of embeddedness between shared value, and the social enterprise, and if these can be complimentary’’. In the context of creating shared value, this paper with the help of financial gradients looks at the financial sustainability of the LaBL programme while the programme simultaneously aims at achieving the goals of sustainable development.
3. The genesis of financial gradients While analysing financial data for Lighting a Billion Lives (LaBL), there was a need to structure the sources of finance. It was noticed that while sources of finance for the corporate sector were well researched and theorized and now an established subject called corporate finance; the same could not be said for the sustainable development sector. It was also seen that not only were the nature of projects differ from the traditional corporate sector, the sources of finance also had differences in terms of ‘nature’: some adhering to conventional norms, while some sources of finance were particular to the sustainable development field and had very different characteristics to any other financial source. Also, sustainable development projects were traditionally thought to be financed only with public finance or grants and aid, however, overtime and certainly in recent times, there was a need to attract other sources. Sometimes it was felt that the nature of the same source was changing as well. For instance, public finance, which primarily consists of government money with fiscal objectives, was becoming more in the nature of soft loans. To sum up the above argument; it can be said that the sources of finance in the sustainable development sector have differences in terms of its nature; plus in the life of the sustainable development action the sources and its nature are dynamic; or the source, nature or both (of finance), change over time. Overall, there is a general tendency or a noticeable trend of the nature of finance in this sector to move away from developmental objectives to an investment category of financing. It was also felt
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Fig. 1. Financial Gradients—the decreasing slope of grant inflows.
that financing of sustainable development projects start with an emphasis on grants; however, if the project has to sustain over long periods of time, then the project should also be financially sustainable. It was noticed that grants were particularly volatile in nature, and in recent times it is increasingly so. There are serious issues the world over with the availability of public finance as a pure expenditure source, with governments wanting to cut down public expenditure, and grants becoming increasingly difficult to avail. Here, we are not saying that the project should be profitable, but merely saying that for the project to continue—there should be sufficient financial inflows to carry on with the project. Once there is a stable and sustainable financial inflow then sustainable development projects will last over a long time say for at least for 25 years or longer. They will have time spans commensurate with major infrastructure projects. However, if the financial backing was being availed only via grants, then it will be difficult to move beyond a three-year time horizon and the project will die an untimely death. In order to avert such a situation, project managers will have to adjust their financial sourcing mechanism, or in other words need to look for a more diffused financial mechanism, where the share of non-grant or non-public finance sources increase. If we view this as a series of yearly bar graphs where the amount of money is on the y-axis and sources on the x-axis, then in the initial years, the slope or gradient will be steep as one transitions from grant participation to say, private equity participation in the project. However, the slope will become more gradual after a few years of the project being in existence. This will be indicative that the project is working well and is attracting investments on its own merits. In general, the diminishing percentage of the grant component is a good sign of the programme, and in Fig. 1 we see precisely that the grant component for the LaBL campaign is decreasing over a period of three years thus indicative of the programme attracting non-grant financial sources including pure investment sources of finance, as we shall see later. Financial gradients can be indicative of the long term viability, sustainability, and acceptability of the project.
4. Financial gradients: a method for financing sustainable development action To develop a financial theory on programmes or projects in the domain of sustainable development is a daunting task. Nonetheless, in this paper, an attempt is made in that direction
following the experience with similar projects in the domain of sustainable development. The recent financial crisis of 2008 has challenged conventional positions in finance. A pertinent conventional view point is elucidated in the Modigliani–Miller proposition (Modigliani and Miller, 1958). It is present in all corporate finance text books, and is considered seminal work in capital structure of the modern corporate. It has served its purpose especially in the corporate sector (Miller, 1988); however, in the wake of the 2008 financial crisis, this proposition has to be understood in a new light—many papers allude to this topic with various entry points; for instance, one looks at it from an entrepreneurial angle (Koch et al., 2010); or from the more holistic viewpoint of mortgages (Ostaszewski, 2009)—the outcome of these papers point towards the premise that the nature and sources of finance are important and crucial from the institutional and extremely important from the governance points of view. The Modigliani–Miller proposition assumes symmetric information and efficient markets. However, given the present scenario, the previous assumptions may not be as valid as originally inferred. An inference can be drawn that the nature and sources of finance play a crucial role in the process of value creation, both at the firm level and more importantly at the institutional level. Another facet of this paper is sustainable development. Sustainable development has evolved over the years, after much deliberation, to include three most crucial aspects of human welfare—economic, social, and environmental—it also includes all common areas between them. Sustainable development has induced a change in thought from a singular focus on economic growth to a more multi-faceted approach. And since the formulation of Agenda 21 in 1992, adopting a development path on the principles of sustainable development has become the goal for a huge majority of countries around the world (Kumar, 2011). Given the new challenges of the financial world and the emergence of the concept of sustainable development, projects and programmes in the domain of sustainable development have to be structured and thought about in a fresh perspective. The method of ‘‘financial gradients’’ is the understanding of the nature and sources of finance. Inherently, a financial commitment is made for a particular purpose; also, the mix of finance in a particular project can guide the results or outcomes, particularly at the institutional level. As we have seen, a seemingly innocuous debt–equity ratio, if not interpreted correctly can cause a global financial crisis. In considering the financial aspects or interactions, the nature of finance with the source of finance are the most important, the change of capital structure over time, the nature of the business model, and so on—all can be considered—but the essence of financial gradients lies in the understanding of these interactions. In other words, there are different aspects or factors in financial theory. These aspects or factors interact with each other, but the most important interactions for ‘financial gradients’ is the interaction between the nature and sources of finance. In each case, the programme or project will have its own story and its own set of priorities, but in the financial sense and especially in the context of sustainable development, the nature and sources of finance are at the core. A case study below will explain this further. There we will see some interesting notions emerging, for example, financing sources like grants, which have low monitoring requirements are actually very expensive, as here the project implementer will have to identify appropriate monitoring mechanisms and pay for it. However, in the case of equity, which has the highest monitoring requirements, as a source of finance it is much less
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expensive, as the equity investor will monitor the project on his or her own self-interest, thus it can be hypothesised that the costs of the project implementer for monitoring is virtually reduced to zero.
5. Financial gradients as an approach Let us recall that financial gradients can be seen as an approach to analyse financial flows in programmes or projects in the sustainable development space. It can develop indicators to assess the health of the project. We can infer that the health of the project is good if the key challenges are met while the project is running. Financial gradients as an approach is described below as a case study for a project in the sustainable development field in the initial years of its activity. 5.1. Case study (All details in terms of data analysis and figures given here are only for exposition. The case study has been developed with the help of the data available from TERI’s Lighting a Billion Lives&a initiative. For further details on the LaBL initiative, refer to the web site http://labl.teriin.org). The key challenges will be addressed and then the analysis will follow using financial gradients approach. The key financial challenge to implement projects in the sustainable development space is to secure long-term, stable finances. This challenge can be broken down to two parts (particularly for non-governmental implementation of projects). First, how does the project diversify the sources of funds; and, second, how does the project scale up funds from all the sources. Given these challenges, it can be said that a programme or project in the sustainable development space has attained credibility in terms of its financial and business models, if there are positive trends in two key financial indicators. First, the overall financial inflows have to increase from all sources—this is particularly true when a project has just started and scaling up is an inherent programme-level requirement. Second, over time the sources of finance should be diversified. Therefore, over time the percentage share from different sources should trend towards a more equal distribution. The project used to describe financial gradients as an approach is Lighting a Billion Lives and is referred to as LaBL hereafter. The period of analysis is from 2008–09 to 2010–11. LaBL funds have been generated through a range of financial instruments, which largely include grants, but also equity investments, loans, syndication, payment for services, research grants, and so on. Apart from the two key challenges, there are a wide variety of questions, which came up and a few relevant ones are given below:
How can the financial flows for the LaBL campaign be analysed
and trends interpreted? J Is there an increase in the volume of financial inflows in the project? J Is there diversification in terms of the sources of finance? Do the trends show progress in financial viability and sustainability of the business model developed by LaBL? To what extent is LaBL leveraging private finance? What is the nature and quantum of public finance being leveraged by LaBL?
To answer the above questions, financial gradients as an approach will be put to use. Now, using the financial gradients methodology, capital ‘‘inflow’’ for the LaBL project will be analysed. For the purpose
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of this analysis, two schemes of classification have been created viz. Sources and Nature. Source identifies the entity providing the fund, while Nature gives us the information about the characteristics of the financial inflow, whether it is equity, debt, public finance or grant, and what kind of tax or other kinds of financial implications are attached to them. All inflow transactions were analysed and clubbed together in different categories within the classes. These were created keeping in mind the sources and nature of the fund. Table 1 will give out the details of each category. The categories were created such that each one is mutually exclusive of the other. Table 2 indicates the nature of financing. Again, the categories have been created such that they are mutually exclusive and give us a clear indication of the evolution of the pattern of financing in LaBL. Table 3 sums up the nature of finance with respect to monitoring requirements very specific to the LaBL programme. Two points to note are as follows. Lower monitoring requirements essentially mean that the cost of monitoring will be much higher. This is because financing sources like grants which have low monitoring requirements are actually very expensive—as here the project implementer will have to figure out monitoring mechanisms and pay for it. However, in case of equity, which has the highest monitoring requirements, as a source of finance is much less expensive, as the equity investor will monitor the project on his or her own selfinterest, thus it can be hypothesised that the costs of the project implementer for monitoring requirement is virtually reduced to zero. One point of information is that a research grant should be interpreted as equity, as the output of the research grant can potentially be monetized and returns can be earned as a result of that. Keeping this in mind then equity and research grant both should constitute equity. 5.2. Case study analysis The bar charts represented in Figs. 2–4, help us understand the financial trends observed in the nature of funds received by LaBL for the three financial years being analysed. From the bar charts, it
Table 1 Sources of LaBL finance. S.No
Source of LaBL finance
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Bilaterals Multilaterals Events Registration charges Co-funding Government Corporate social responsibility Institutional social responsibility Individuals Payment for services
Table 2 Nature of LaBL finance. S.No
Nature of LaBL finance
1. 2. 3. 4. 5.
Pure grant Research grant Loans (soft or otherwise) Equity (including co-funding) Public expenditure
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Table 3 Nature of finance and monitoring requirements. Category
Definition
Monitoring requirement
Pure grant Research grant Public expenditure/subsidy Loans Equity
Funds given as a part of philanthropic activity or partly with an intention to claim tax exemption Funds given with a research objective and a tangible outcome is expected (a report, a product etc.) Government funds with fiscal objectives Funds provided by a bank with a ToR similar to retail lending User/community/entrepreneur contribution towards the project hardware cost
Negligible Low Medium High Highest
Fig. 5. Inflow in Indian Rupees (INR) from 2008–09 to 2010–11.
Fig. 2. Financial Inflows for the year 2008–09.
Fig. 3. Financial Inflows for the year 2009–10.
Fig. 4. Financial Inflows for the year 2010–11.
can be inferred that there is a movement from a pure grant-based method of financing to a more community or private equitybased method of financing. This equity-driven model will get further impetus when there are more lines of business, like provisions for charging for mobile telephony in addition to charging solar lanterns, are attached to the core model. There are various possibilities of increasing lines of businesses; however, the charts below for the first three years are purely for solar lanterns as the only line of business. It can be seen from the bar charts that in the first year of LaBL’s operation, there was no equity component. This then rises to 1% in the second year and then to 7% in the third year. We also see that the pure grant component is decreasing rapidly from an ominous 91% in the first year to 81% in the second, and a far more viable 66% in the third year. If we add the research grant to pure equity, we find that the equity component is doing very well, from a 7% in the first year to 16% in the second year, and finally a very promising 27% in the third year. Overall, the non-grant finances are rising fast from 9% to 19% and then to 34% in the final year. We should remember that this strong performance in building a sustainable financial model was built with only one line of business; the charging stations have the potential to stand alone as a viable business without any grant component in the future when more lines of businesses are included. Also, we must note that here we have talked in terms of percentages, we must bear in mind that in absolute numbers (or amount of money being allocated for LaBL) there has been huge increase across all categories. The picture above is surely a cheerful picture for ‘sustainable’ business models in ‘‘real life’’. In Fig. 5, we can see that there was an overall increase in financial inflows from year to year, and also we can see that each individual component also saw an increase in magnitude of financial inflows. The analysis so far outlines two gradients as key—one, an increase in total finance which is an indication of scaling up of efforts as funds are invested towards workable solutions and second, decrease in non-investment category finance, particularly grants, as a percentage of total finance.
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Fig. 6. Project Costs over time in Indian Rupees (INR) from 2008–09 to 2015 (projected).
A third kind of gradient that would be essential to assess the sustainability of projects in the domain of sustainable development would be to see the financial help (mostly government subsidy or grant) per beneficiary decrease as scaled up efforts reach economies of scale and a decrease in the risk capital required to broaden the domain of activities within the projects. Fig. 6 captures this aspect. We can see that with time as efforts are scaled up the project costs reduce significantly and will reduce further as the outreach and domain of activities under the programme increase.
mechanism prevalent in the sustainable development and climate action space. However, much more research needs to be done and many case studies applying the financial gradients method needs to be carried out to make financial gradients a robust and implementable concept.
Appendix A. Supporting information Supplementary data associated with this article can be found in the online version at doi:10.1016/j.enpol.2012.03.038.
5.3. Case study conclusion There is a clear trend that the grant component is decreasing and the equity component, both pure and in other forms, is increasing. We also see that the total funding across all components is increasing as well. This definitely augurs well for the LaBL finance models. There is a clear trend that LaBL finance is moving from a pure grant-driven financial model to a more flexible model where private or investment category financing mechanisms are playing larger roles. We can also see that the two key indicators, one of scaling up financial inflows, and second, of achieving diversification from the point of view of sources of finance was also achieved.
6. Summary In this paper, we have addressed the central debate in sustainable development finance, and noted that sustainable development action needs to attract investment-grade financing sources. The paper notes that sustainable development action and climate action have a common goal and financing both has a common problem. The key is to understand both—the nature and sources of financial inflows as well as the synergy between them. To address this problem, the concept of ‘‘financial gradients’’ has been developed. ‘Financial gradients’ is a method of understanding financial flows in relation to the nature and sources of these flows. It can give us an indication of the health of a sustainable development programme. The case study in this paper reflects that it has the potential to develop better understanding of the financial
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