Renewable Energy Certificates (RECs) have been in existence in India since 2011 to enable compliance of Renewable Purchase Obligations (RPOs). The country has made some progress towards creating a market mechanism for RECs, but a lot more needs to be done to realise their full potential as a mechanism to finance and boost renewable energy generation capacity.

A well-implemented REC policy can provide an effective financing mechanism for renewable energy projects. It is important for the government to look at improving the REC ecosystem.

First, the regulatory regime around RPOs needs to be improved with a more effective "carrot and stick" mechanism for obligated entities. In their paper, "Promotion of Wind and Solar Energy through Renewable Energy Certificate System: Lessons from Renewable Obligation Certificate, United Kingdom Experience for India", Sushanta K. Chatterjee, et al., put forth the example of regulations in the UK that pool the penalties received for non-compliance of RPOs, and uses the pool to reward compliant entities.

A regulatory mechanism that both rewards compliance and penalises for non-compliance may potentially yield better results. For India to move towards energy independence and clean energy generation at an even more rapid pace, such compliance will be essential. Better compliance will lead to the REC market being more robust, which in turn will make financiers of renewable energy projects more confident of the REC mechanism. Thus both increasing the availability of capital and lowering the cost of capital.

There is also the need to expand the REC market gradually by both allowing an Over the Counter (OTC) Market to develop in REC trading (currently RECs can only be traded on an exchange) and allowing for a REC forward curve to develop. Allowing an OTC market will potentially allow greater participation in the market. A REC forward curve will allow more price discovery to the market participants.

The development of both an OTC market and a REC forward curve will need market makers in RECs. They will be able to provide the market some level of liquidity and greater price discovery. It will also be important to "deregulate" the market to some extent as far as the price bands are concerned. The question of increasing the band width between the floor and forbearance price deserves consideration.

The market should, in effect, determine the price based on the quantity of RECs available and basic economics tells us that the quantity available will react to the price-quantity equilibrium established. That said, all this hinges on strict RPO enforcement.

In addition, bilateral OTC transactions will assist in price discovery in the market. A forward curve will assist in long-term decision-making, a key aspect in long-dated renewable energy projects.

In an ideal scenario, a well-functioning and liquid forward curve may allow developers to raise and lock-in funding for long-dated projects by selling RECs that will be generated in the future to buyers. While we are a long way away from this, we must aim for such a liquid and well function market. Such a market will make financing for REC projects flexible and significantly cheaper.

A well-functioning REC trading market will allow an effective financing mechanism to boost the renewable energy market in India. So far, given the lack of bankability of the REC mechanism, financiers haven't been able to have confidence in it to the extent required.

For India to seriously leverage the REC financing mechanism it is urgently required that policymakers look at improving and building the REC market. Given the ambitious targets the country has and the need for clean energy globally, a fillip to the REC mechanism is essential.

(Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm. The views expressed are personal. He can be contacted at taponeel.mukherjee@development-tracks.com or @Taponeel on Twitter)

REC: A must for India to achieve renewable energy targets