Allocating currency risk in renewable power finance: tariff indexation, hedging, and sovereign guarantees

Emerging nations’ renewable energy investments are frequently hampered by currency risk resulting from the mismatch between local-currency revenues and foreign-currency funding. Though financial hedging, tariff indexation, and sovereign guarantees are often employed to reduce this risk, present studies usually treat these tools separately. Under exchange-rate uncertainty, this study creates a single framework combining all three channels into a unified project-finance model of renewable energy investment. Key features of renewable energy finance are captured by the model, including long-term power purchase agreements, limited hedging markets, and government involvement through guarantees. It defines how, in equilibrium, tariff indexation, private hedging, and government guarantees interact to distribute currency risk among investors, consumers, and the public sector. The research reveals three major observations. Private hedging first reacts endogenously to governmental policy decisions; more indexation or guarantees crowd out financial risk management. Second, while financial hedging rules in deep markets prevail, tariff indexation is somewhat more successful in volatile settings. Third, while sovereign guarantees enhance project bankability, they could transfer risk to public balance sheets. The paper proposes a least-cost risk absorption principle and offers advice on creating currency-risk reduction plans that strike a compromise between fiscal sustainability and investment incentives.