WHAT WE READING – Vol.

 INDIA’s Known Unknowns

A Macro framework

 FII Flows in INDIA

Against all odds, they continue to flow in

 We need a ‘ Credible ’ and not an ‘ Incredible ‘ INDIA

The Path to prosperity

 Rural India Tour

An anticipatory & qualitative survey

 Changing face of Financial Statements in India – Revised Schedule VI

Increased disclosures – Benefits & Limitations

 Financial Inclusion Enablers

Game changer for both Banking & Consumers

 Fund Management / Investing is the most difficult profession in the world.

No other domain has benchmarking the way this does

 Deflation in a Fiat World

Role of Emerging markets in Money-supply growth

 Is it Apple vs Samsung OR Samsung vs Apple !

A global war for consumers on patents & operating systems

 Black Swan thesis for Energy Technologies

What can change assumptions in the Energy sector !

 Canvas of The World

My world vs your world

 KHAN Academy

A Game changer in Education delivery

September 10, 2012

INSIGHTS

MORGAN STANLEY RESEARCH

India Strategy Asia

Morgan Stanley India Company Private

The Known Unknowns and Market Outlook: A Framework Limited+

Outlining triggers for market performance excess return, depressed asset turn and tepid growth Ridham Desai 

The list of known unknowns is a long one, given the macro
set-up. To be sure, share prices can rise even in such an
environment if expectations are low. From a market
perspective, we highlight some fairly obvious triggers:
a) The market is acutely sensitive to global outcomes, in
fact, much more than to local outcomes, if return
correlations are an indication. This could partly explain the
staleness of local bad news or the lack of forcefully positive
news to dampen correlations.
b) Then again, there is strong fundamental reason for
India’s high correlation with global markets. Global
outcomes affect India’s macro stability, given the twin
deficit, even as the market is more concerned with the
delta in the twin deficit rather than just the level.
c) There is a concurrent inflation impact (commodity
prices) and, in turn, there are monetary policy implications.
India’s BoP, and thus interest rates, is also tied to global
outcomes, and, eventually, growth feeds from it.
d) Back home, the most crucial factors are the investment
rate and fiscal consolidation. The former could change if
the public sector presses the throttle. The private sector
will likely remain reluctant to invest, given the low level of
outlook. Fiscal consolidation faces political challenges,
Sheela Rathi 
as do overall reforms, and meaningful change is not a
base-case outcome.
Utkarsh Khandelwal 
How does all this feed into the market outlook? M1
growth has put in a firm base, indicating stable revenue Amruta Pabalkar 
growth or even an acceleration. Improving liquidity has
caused short-term rates to fall YoY. If the global risk
appetite remains stable, rates will likely stay lower YoY.
The prospects of a faster fall in the current account
deficit relative to the fiscal deficit are good for profit
margins, albeit with an assumption that the investment
rate does not collapse. The outlook on profits may be
better at the margin, but conviction is still low. The best
news on profits is that consensus expectations are low
and hence scope for upside surprise is rising.
Sentiment remains fragile, if our proprietary sentiment
indicator is a guide. Liquidity is better at the margin, as
we noted, but still not firmly in favor of stocks. In the end,
Subscribe to India Strategy Research
it is about what’s in the price. Arguably, valuations are
attractive, notwithstanding the dispersion. Please see
chart on page 2 for a detailed pictorial representation.

Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the
firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research
as only a single factor in making their investment decision.
For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.
+= Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject
company, public appearances and trading securities held by a research analyst account.
 MORGAN STANLEY RESEARCH
India Strategy
Sept. 10, 2012

The Known Unknowns

Macro Stability & Investment Cycle

Rates & Growth

Capital Flows

Global
Current Account Deficit: Government Policies
Oil, Gold
QE3 Fiscal Deficit
Inflation Mid Term Polls
Infrastructure and/or
Europe PSE capex
Private Sector Capex
Monetary Policy/Rates

China

Liquidity
Corporate Fundamentals What’s in the price
& Sentiment

Market Outlook

2
Source: Morgan Stanley Research
Foreign investment in India

They just keep on keeping on

Against all the odds foreign investors continue to pile into India. Why?

Sep 8th 2012 | MUMBAI | from the print edition ECONOMIST

AT THE start of 2012 India offered a cocktail that seemed guaranteed to be lethal for foreign investment: a
faltering economy, corruption and political gridlock. In March came the final flourish, the equivalent of the
barman spitting into your Death in the Afternoon. A budget was passed that aimed retroactively to tax
Vodafone, the country’s biggest foreign direct investor, and to clamp down on the holding structures used
by most foreign investors, in particular the routing of money through the low-tax paradise of Mauritius.

In April alone, foreigners sold almost $1 billion of portfolio investments in listed shares and debt. Such
outflows are scary. India runs a current-account deficit, which it aims to plug with portfolio inflows and
foreign direct investment. After a record deficit relative to GDP of 4.2% in the year to March 2012, the
deficit this fiscal year is expected to be 3-3.5% of GDP, or $50 billion-60 billion. To fund that kind of gap
safely, India needs the world to be bullish about it most of the time.

Since April, however, portfolio investors have piled back in

(see chart), with net buying of some $5 billion of shares and
bonds. This is surprising. There has been no clear
improvement in India’s fortunes. Yes, there is a new finance
minister and those tax rules have been delayed and diluted
(although Vodafone’s fate is still unclear). But the political
climate has soured further, lessening the chances of reforms
or more prudent fiscal policy. Private firms are still reluctant
to invest. A credit-rating downgrade to junk status looms.
Stockbrokers say that their usual foreign clients—pension
and mutual funds, and specialist India funds—are bearish.
“The people who know India are not buying,” says one.

So who is? The figures on portfolio flows are a puzzle.

Sanjeev Prasad of Kotak, a broker, studied inflows in the
2011 fiscal year, and found only a fifth could be explained by mainstream funds (excluding most sovereign-
wealth funds, where data are scarce). Conspiracy theories abound. Indian firms are siphoning cash out of
and then back into the country to avoid tax, or to prop up their own shares, some say. Many believe there is
a vast pool of dodgy offshore money owned by Indians, which is brought home in dribs and drabs. Even
the central bank worries about the quality of capital flows.

Some of this year’s inflows may reflect a statistical quirk surrounding the sale of a stake in an Indian bank
by Citigroup. But another possibility is buying by sovereign-wealth funds keen to diversify from America
and Europe, with their zombie economies and rock-bottom interest rates. Neelkanth Mishra of Credit
Suisse, a well-known bear on India’s immediate outlook, reckons investors with decades-long horizons are
still being drawn by India’s demography and rising middle class.

That might explain a paradox. The best-performing shares are not in sectors that would benefit from a
recovery, such as infrastructure and banks. Instead what have soared are the share prices of firms that seem
able to grow however bad the rest of the economy is. Consumer-goods firms such as Hindustan Unilever
and Nestlé’s Indian arm now trade on their most expensive multiple of profits since the late 1990s, when
the economy was last in the doldrums. The capital flows that India is attracting may say more about the
resilience of some of its firms than about the odds of a rapid bounce in its economy.
 Credible India
by Sundeep Waslekar | Aug 27, 2012

Hope is the most important input for growth in any country. All hope asks for is focus to build a nation
that is humble, compassionate and above all else, a great one
Stone me for saying this. But say, I must. The great Indian obsession with wanting to be a great power is
utterly impractical, completely undesirable and totally nonsensical. What I would like India to be instead is
a great nation. I refuse to be a part of “Incredible India”. What I want is to be part of “Credible India”. This,
for two reasons:

 Great powers destroy, great nations nurture. Destruction demands cruelty. Nurturing demands
compassion. I believe in compassion.
 Great powers are built by rulers. Great nations are built by citizens who have as much a chance to take a
stab at greatness as their leaders. I believe in equality.

Both of my beliefs, as much as they are intensely personal, are rooted in history as well.

The way forward

First, ask the most basic of all questions. Ought a nation to measure its success in terms of GDP growth or
in terms of the human development quotient?

I believe nations that measure success in terms of GDP are prone to violent disruptions. That, to my mind,
explains our susceptibility to terrorists. Norway, on the other hand, has a stated policy that policing will be
kept to the minimum. That explains why Scandinavian countries are of no interest to terrorists. When you
elicit no response, what is the incentive in attempting?

In making this transition, disruption is inevitable. But you could choose between managed positive
disruption, or enforced violent disruption.
To understand this, turn to Turkey once again. What happened there was that a group of politicians got
together and built new terms of reference for what a nation ought to be like. To do that, they hired a market
research agency to ask people what they want. Everything people said boiled down to two words—justice
and development. Armed with this insight, the Justice and Development Party was formed—the acronym
for which in Turkish is AKP—and is now in power.

Effectively, they used modern tools from mainstream business to understand grassroots problems and
arrive at a political conclusion. They presented their findings and agenda to the people and got elected into
office.

In Singapore, though, change was imposed. In the process, it compromised on civil liberties. However,
they’ve achieved 70-80 percent of what they set out to do.
Change in Malaysia was similar to what happened in Turkey. In 1968, following racial riots, leaders cutting
across communities came together and agreed they wouldn’t allow violence to happen again. So they made
a constitutional amendment that mandated any elected cabinet to have representatives of the three major
races in the country. They realised political engineering can be used to resolve other problems as well,
including economic ones.

I don’t see any signs of that happening in India. My beliefs compel me to argue that what India suffers
from is a crisis of vision, ethics and courage. Put these values together and what you have is statesmanship.
That is why even 60 years after his death, Mahatma Gandhi is still remembered. He had an ethical code,
and courage. Lee Kuan Yew, the first prime minister of Singapore, is someone I think of in that mould. He
once told me something interesting—that one of the driving forces in his life was a nursery rhyme.

Humpty Dumpty sat on a wall,

Humpty Dumpty had a great fall,
and all the king’s horses,
and all the king’s men,
couldn’t put Humpty together again.

He said he read it a few times every single day after he became prime minister. Because, he said, it
underscores an important political statement. If your national resources, whether human, natural, or
entrepreneurial, fail and go out, all the kings, their men and horses can’t put them together again. “So I had
to create a vested interest in the nation of Singapore, not by using power but by using ideas.”

He couldn’t have put it any better. Great nations are built on the back of ideas—not force.

About the author

Sundeep Waslekar is the president of Strategic Foresight Group, a think tank based in India that advises
governments and institutions around the world on managing future challenges.

He was instrumental in creating the concept of The Cost of Conflict in the Middle East, based on a complex
set of parameters, which has since then become the main tool for negotiations in the region. He also crafted
the concept of Blue Peace, which looks at how water can be used as an instrument of peace. Switzerland
has adopted this concept as part of its state policy, and the Swedish and British governments will soon
follow suit
 ENAM Rural 2012

ENAM RURAL SURVEY

 Objective: Rural India is a prime driver of both Consumption and Politics. Structural variables
and Govt steroids over the last few years have kept rural consumption robust. However,
Consumption has been stressed of late, exacerbated by a weak monsoon. Rural stress levels can
deeply affect political thinking and action, esp given general elections in 2014 (or maybe
earlier).
 Hence the need to assess first-hand, any changes in structural trends in rural income levels and
consumption patterns, apart from ST monsoon related worries.
 Intensive rural survey in 23 small towns & surrounding villages across 5 states.
 States covered: developed (Punjab, Gujarat & Mah), developing (Karnataka) and
underdeveloped (UP).
 Met the following in each town:
 Government officials, groups of small/large farmers, lenders, distributors/ traders/ retailers/
trade associations in agri-markets, FMCG, auto and farm inputs.
 Caveats:
 Survey is anticipatory, to get the Rural Pulse as of now. Any meaningful changes in demand
and/ or its effect on inflation would be more pronounced once the festive/ harvesting season
starts (~November).
 Survey is qualitative (intensive v/s extensive), to understand trends, not measure and quantify.
 Apart from the key findings and various interesting insights that we gleaned, we have also
included in our report, our previously released 10 year study on the correlation of various
factors (not just monsoon) to rural consumption.

KEY TAKEAWAYS
Status of Monsoons: The South-West Monsoon (June-Sep) this time was delayed and very weak.
Important rain-fed agri regions in Maharashtra, Karnataka and Gujarat (oilseeds, cotton, sugar,
coarse grains) have been the worst affected, while important cereal-growing regions in the North
are relatively better off despite scanty rains. While of late the rain deficit has come down to 10%,
late sowing and weak rains will also bring down overall crop yields.

Inflation v/s Output pressures: While sowing acreage has shrunk, late rains will buffer some of
the low-yield effect and protect the winter crop. Govt also has record grain stocks, which however,
need to be deployed in time. Thus while we expect muted price pressure on cereals, prices for
vegetables, sugar cane, fruits, etc are likely to spike. Their impact would be felt towards November
when festive demand picks up post-harvest, and as stocks run down. Thus, we expect overall WPI
inflation to avg ~8% in FY13 (vs 7.5% earlier).

Rural Income: Rural income: Rural demand to weaken due to rising farm costs, poor monsoons,
and weakness in Services growth. Thus, private consumption (~57% of GDP) growth, that has
been the mainstay of India’s overall growth, is likely to remain erratic and below potential:

SEPTEMBER 2012 1
 ENAM Rural 2012

 Viability: Agriculture (> 50% of rural income) is becoming unprofitable for majority of farmers
who have small land holdings, as input costs have risen far more than incomes (MSPs).
 Input Costs: NREGA impacting both availability and cost of labour. Increase in Fertiliser costs
(international prices and weaker INR) and Diesel costs (unit cost and greater requirement due
to poor rains).
 Share of Wallet: Despite rising income (share of food should have fallen), high inflation has led
to a rise for rural India – for the first time in the last several years.
 Non-agri Incomes: Slowdown in Govt/ pvt infra spend, leading to slowing Construction,
which accounts for a bulk of non-agri jobs.

Cost Dynamics for farmers (UP) for wheat

Amt ( R s) Amt ( R s)
While MSPs have
Partic ulars Units % Chng 2012 2009
risen ~8-12% and
Yield per acre quintal 11 20 18
farm income has Realisation Rs/qntl 4 1,120 1,080
risen 15%, cost of Farm Inc ome/ ac re 15 22,400 19,440
cultivation has risen Cultivation c Cost per hec
faster @90%, Direc t f arm input c ost 81 7,800 4,300
eroding farm Seeds 2,300 1,500
profitability Fertilisers 4,000 2,300
Pesticides/Weedicides 1,500 500
Labour intensive proc ess c ost 90 28,500 15,000
Sowing & Irrigation cost 18,000 11,000
Harvesting cost 7,500 3,000
Others 3,000 1,000
Aggregate Cultivation c ost/ hec 36,300 19,300
Aggregate Cultivation c ost/ ac re 88 14,520 7,720
N et Inc ome/ ac re ( 33) 7,880 11,720
Source: Survey anecdotes and Govt documents

Diesel can increase total farm input cost by ~20% in a

bad monsoon year for paddy
Diesel cost can lead C ultivation C ost per hec (Rs) D eficient Adequate
to 20% increase in for Paddy rainfall rainfall
total farm input Seeds 2,000 2,000
costs for farmers: Fertilisers 4,000 4,000
hence the delay in Pesticides/Weedicides 2,600 2,600
Harvesting cost 5,500 5,500
diesel price hike
Sowing costs 6,500 6,500
Others 11,000 11,000
Total costs except irrig ation 3 1 ,6 0 0 3 1 ,6 0 0
Irrigation cost * 10,500 3,000
Total farm input cost 4 2 ,1 0 0 3 4 ,6 0 0
Source: Survey anecdotes and Govt documents * Paddy being a water-intensive crop needs 7-8
irrigation cycles if rains not adequate

SEPTEMBER 2012 2
 ENAM Rural 2012

Banking:
 Asset quality of agri loans, which account for 12% of total bank credit, likely to be under
pressure due to lower farm income levels (poor monsoon), expectations of debt waiver by
farmers, and an unofficial ‘go-slow’ by state administration on recovery of farm loans (as
general elections are due in 2014). Specifically, PSU banks are directed to disburse more “crop
loans” which have some subvention from the Govt – which is why pvt banks largely can’t
compete here. However, crop loans are the most vulnerable part of agri-lending to defaults.

Agri Supply Chain

 Food grains stocks are abundant on an all-India basis. Govt has been aggressive in stocking
wheat in UP, where wholesalers have been asked to procure ~25% of wheat on behalf of the
govt, failing which their licenses may be revoked. Also in UP, paddy stocks are lower this year
and late sowing will impact output by ~20%. Hence traders in UP expect a jump (20-30%) in
paddy prices once the festive season arrives as govt supplies usually do not reach in time at all
places, and cool off later as they arrive.
 Crop switching not much in evidence except in Maharashtra where farmers have switched
from sugarcane to vegetables (and to corn/ soya in some areas to take advantage of the
massive crop failure in the US).
 Sowing of Sugarcane is down 40-60% in Maharashtra and Karnataka, but normal in UP and
TN. All-India output to be impacted by both lower yields and acreage. Sowing of coarse grains
ie Bajra, Jowar hit in most states. Onion output is likely to be down ~50-60% YoY in
Maharashtra and prices could go up 20-30% as no new produce is expected (onions currently
in the market are from last year’s inventory).
 Thus, prices of veggies such as onions may rise more than cereals where govt has adequate
buffer.
 APMC/FCI* well penetrated but not preferred by small farmers due to delays, rampant
corruption and adverse terms of trade. Small farmers usually sell < MSP at mandis. However,
this time around, farmers in UP were getting prices higher than MSP as the govt has crowded
out other buyers.
* APMC: Agricultural produce marketing committee; FCI: Food corporation of India

Auto
 Inventory levels high across segments, especially tractors and two wheelers
 Demand slowdown visible, but will actually show up post harvest season (Nov/Dec).
 Discounting, largely in petrol cars and M&HCVs. Expect discounting to start in other
segments post harvesting, if…
 Demand decline in two wheelers/tractors least in Punjab/Gujarat which are well irrigated and
have alternate income sources.
 In two wheelers, good response for Honda’s Dream Yuga.
 In CVs, slowdown visible in M&HCVs and starting in small CVs (up to 3.5 tons).

SEPTEMBER 2012 3
 ENAM Rural 2012

FMCG
 Rural demand (~35% of FMCG market) weaker relative to last year. Discretionary income
squeezed by inflation in both farm inputs and consumption basket.
 Down trading is visible in discretionary and non-discretionary categories.
 Rising cost pressure for FMCG players in the 2nd half of FY13, could impact operating
margins.
 Pricing power to weaken due to lackluster volume growth. Increase in pricing differential
between national brands and local brands leading to local brands gaining traction.

Farm inputs

 High prices, weak rainfall hurting complex fertilizer demand: Sharp jump in DAP prices (2.5x
in last 12 months) and weak rainfall has led to a sharp decline in DAP usage by farmers.
Farmers have shifted from DAP to NPK fertilizers, which are cheaper than DAP.
 Urea demand impacted but to a lower extent: Urea demand shrinkage is lower due to lower
prices and it being a necessity (P, K retention in soil for 24 months, versus N retention of a
single season).
 Branded Fertilizers preferred by farmers: Farmers are ready to pay slight premium for
branded fertilizers as they have uniform size and texture, which farmers associate with better
quality.
 Seed demand largely un impacted: Seed demand has largely been un impacted but there has
been down-trading in seed consumption as farmers reduced risk of losses due to lower yields.
 Increased usage of spray Fertilizers: Due to high labor costs, farmers nowadays prefer
sprayable variety of fertilizers, which can be directly sprayed versus manual application.
 Increased usage of weedicides: Farmers are using high proportion of weedicides as manual
labor for weed removal is costly.
 High DAP & Urea usage in North India misleading: Farmers in Punjab and UP treat Urea &
DAP usage as a status symbol and hence use it regardless of need and affordability. This is
DESPITE extensive awareness programs by agricultural universities and state agriculture
department entities.
 Labor costs, increasing seeds, DAP costs and higher usage of Diesel (for running pumps for
irrigation due to lack of rainfalls) are key concerns for farmers.
Government initiatives: The thrust would be in the worst hit states of Maharashtra and Karnataka
 Cereal reserves with the govt are high and would be made available as required. Serious issues
would be in availability of water and fodder.
 Diesel subsidy: 50% diesel subsidy to farmers in drought-affected areas, which will be equally
shared by the state and the centre.
 Increased workdays under NREGA in notified sub-districts in Maharashtra increased to 150
from 100 recently.
 Loan waiver of upto Rs 25,000 in Karnataka on loans from cooperative societies over the past
year.
 Free cattle fodder centres in Maharashtra and Karnataka

SEPTEMBER 2012 4
 ENAM Rural 2012

Monsoon and rural demand – a 10 year study

The South-West Monsoon (June-Sep) this time was delayed and weak. While of late the deficit has
come down to 10%, late sowing and weak rains will also bring down overall crop yields.

Rural demand v/s Monsoons: Rural income/ consumption is only PARTLY dependant on the
strength of monsoons. For eg monsoons were ~20% deficient in FY03 & FY 10, and dispersion was
equally poor and yet, agri GDP fell by 7% in FY 03 v/s rose 1% in FY 10.

Our 10 year study shows the correlation between various aspects of rural demand (eg agri-GDP,
auto sales, FMCG sales, etc) and the following factors, as shown in the table overleaf:

1. Monsoons: All 3 factors ie quantum, timing & geographical dispersion are important. The
water reservoir & table levels (which are partly determined by the PREVIOUS year’s
monsoons) also affect agri production; the winter crop thus partly depends on the water table
resulting from the monsoons. Thus, deficient monsoons for 2 years in a row is particularly
damaging, eg in 2002 & 03, and in Mah/ Karnataka this year
2. Crop vulnerability: The Govt’s existing food grain inventories obviously buffer the damage –
eg inventories are high this year
3. Rural income determinants: institutional credit to agriculture, rural policy measures (MSP,
NREGA, etc). One of the biggest drivers is overall GDP growth, as non-agri activities (i.e.
construction, trading and services, etc) now contribute ~50% of rural income.

Drought episodes of FY03 v/s FY10 :

 FY03: Agri GDP contracted 7% while IIP-index (for consumer durables) and FMCG rural sales
experienced de-growth of 6% and 8% respectively. Note, there were no policy levers such as
NREGA etc to boost incomes and even MSP increase was inadequate.
 FY10: Agri-GDP increased 1% YoY. The drought dealt a severe blow to production of paddy,
coarse cereals and oilseeds. Yet, Rural FMCG sales grew at a staggering 21% (highest in past 5
years) while tractor and 2-wheeler sales grew 32% and 26% respectively. The Monsoon impact
was negligible and this is mostly explained by other rural growth facilitators such as Farm
debt waiver, MSP increases, NREGA disbursement, Agri-credit growth, increase in food
procurement, etc.

SEPTEMBER 2012 5
 ANALYSIS BEYOND CONSENSUS
…THE NEW ABC OF RESEARCH
Revised Schedule VI: Disclosures galore; benefits to accrue

Changing face of financial statements

Indian corporates are increasingly getting innovative in the preparation of financial
statements. With a view to bring about greater transparency to investors and readers
of financial statements, the Ministry of Corporate Affairs (MCA) has modified the
existing ‘Schedule VI’ format (‘old format’) of Companies Act, 1956. Schedule VI lays
down the format for the presentation and disclosure of Balance Sheet (BS) and Profit &
Loss account. The ‘new format’ named ‘Revised Schedule VI’ is yet another step in the
right direction for ultimately migrating towards IFRS.

Why should investors take note of this revision?

We believe that the revised format will facilitate better analysis of financial statements
by disclosing:

• Asset-liability mismatch on the face of BS

• Full details of convertible instruments

• Bifurcation of sundry creditors into creditors for operating activities and others
(will assist in accurate forecasting of payable days/operating cash flows)

• Current maturity of long-term debt (debt repayable within one year) will be
disclosed separately under ‘Other current liabilities’

• Detailed bifurcation of addition to fixed assets (amalgamation/other adjustments)

will be disclosed separately

• Debtors exceeding six months post due date of payment.

Revised Schedule VI is applicable to all companies for preparation of financial

statements and IPOs for the financial year commencing on or after April 1, 2011.

The new format has been mandated for standalone financial statements and
consolidated financial statements, however, certain disclosures such as CIF value of
imports, foreign currency expenditure and earnings are required only at the standalone
level. The companies would be required to provide comparative fiscal years’ figure in
the new format. Accordingly, FY11 financial statements figures will be regrouped and Manoj Bahety, CFA
+91 22 6623 3362
stated as per the new format.
manoj.bahety@edelcap.com

Revised Schedule VI is not applicable to companies for whom the format for financial Sandeep Gupta
statements is already specified (like banking and insurance companies). Further, SEBI +91 22 4063 5474
sandeep.gupta@edelcap.com
has by recent amendment rolled out the format for reporting quarterly financials in line
with Revised Schedule VI. Ashish Gupta
+91 22 6623 3488
ashishs.gupta@edelcap.com
For live illustrations of changes in FY11 financials – Refer annexure

Analysis beyond Consensus (ABC) is our initiative to provide a differentiated perspective to our clients on
various non-routine and intricate issues. This unit of research works independent of the sector/stock May 8, 2012
research team and views expressed in this report may vary with that of respective sector/stock analyst.

Edelweiss Research is also available on www.edelresearch.com, Edelweiss Securities Limited

1
Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.
 Analysis Beyond Consensus
Table 1: Summary of key changes in Schedule VI
Old Schedule VI
Balance sheet is divided into operating and
financial liabilities
Terms of convertible securities were stated at the
standalone level only
Sundry creditors includes creditors for goods,
capex, other contractual obligations, etc.
Ambiguity on classification of acceptances
Loan funds of a company are separately disclosed
on the face of balance sheet on half-yearly basis
Under reconciliation of fixed assets, disclosure
mandated only for opening, additions, deletions
and closing block
Debit balance of P&L account was stated on the
asset side of Balance sheet
Only capital commitments need to be disclosed
Debtors outstanding exceeding six months from
billing date need to be separately disclosed
Details provided about installed capacity and
actual production are disclosed
Quantitative details with respect to opening
stock, purchases, consumption and closing stock
are disclosed
Revised Schedule VI
Break-up of balance sheet into current and non-
current assets/liabilities
Terms of material convertible preference shares
or debentures along with date of conversion will
be available for subsdiaries also
Sundry creditors replaced with the term 'Trade
payables' which will include creditors for
goods/expenses in normal course of business.
Creditors for capital goods and other contractual
obligations not to form part of trade payables
Acceptances for raw materials should be
disclosed along with trade payables
Loan funds are split as short-term borrowings
and long-term borrowings on half-yearly basis.
Further, long-term borrowings maturing within
twelve months will be disclosed under ‘Other
current liabilities’
Reconciliation of fixed assets should apart from
earlier details also include assets acquired on
acquisition, adjustments due to exchange
fluctuations under non-integral operations, etc.
Debit balance of P&L account is to be disclosed as
a reduction under the reserves and surplus
schedule
All commitments (capital, operating or otherwise)
needs to be disclosed
Debtors outstanding exceeding six months from
due date of payment need to be separately
disclosed
No details to be provided
No details to be provided
2 Edelweiss Securities Limited
What's in for us Good / Bad
Investors would be in a position to know the Good
asset-liability mismatch
- Analysts will be able to estimate cash flows Good
accurately
- Analysts will be in a position to state whether
and how much equity dilution/ROE dilution is
likely to occur
Analysts would be in a position to accurately Good
calculate the average payable days, which will
help in accurate calculation of the cash
conversion cycle
Under the revised format also, Bad
acceptances/supplier's credit will form part of
operating activity, however, the cost of such
acceptances will continue to form part of finance
expenses
The amount for current portion of long-term debt Bad
embedded in Other current liabilities will only be
annually available
Analysts would be in a position to distinguish Good
between cash capex and other adjustments
Reserves and surplus balance would present an Good
accurate picture under the revised schedule VI
Investors will have complete information of all Good
long-term non-cancellable contracts entered into
by the company
Debtors exceeding due date of payment provides Bad
details about debtors which have turned sticky.
Accordingly, provision for these accounts will be
strongly encouraged
Analysts would have to rely on communication Bad
from the companies in quarterly presentations
and details for details of actual production
No quantitative disclosure would prevent Bad
analysts in certain industries such as cement,
metals, FMCG not being able to use the required
information
Source: Edelweiss research
 FINANCIAL INCLUSION ENABLERS

Game changers for both Banking & Consumers

(I) NATIONAL PAYMENTS CORP. of INDIA

http://www.npci.org.in
RBI after setting up of the Board for Payment and Settlement
Systems in 2005, released a vision document incorporating a
proposal to set up an umbrella institution for all the RETAIL
PAYMENT SYSTEMS in the country. The core objective was to
consolidate and integrate the multiple systems with varying
service levels into nation-wide uniform and standard business
process for all retail payment systems. The other objective was
to facilitate an affordable payment mechanism to benefit the
common man across the country and help financial inclusion

Key Services :

1. National Financial Switch ( NFS )

The Institute of Development and Research in Banking Technology (IDRBT), Hyderabad had been providing
ATM switching service to banks in India through National Financial Switch. This is now overseen by NPCI.

2. Interbank Mobile Payment Service ( IMPS )

Currently majority of interbank mobile fund transfer transactions are channelized through NEFT mechanism.
Under NEFT, the transactions are processed and settled in batches, hence are not real time. Also, the transactions
can be done only during the working hours of the RTGS system.

IMPS offers an instant, 24X7, interbank electronic fund transfer service through mobile phones. IMPS facilitate
customers to use mobile instruments as a channel for accessing their bank accounts and put high interbank fund
transfers in a secured manner with immediate confirmation features.

This facility is provided by NPCI through its existing NFS switch.

 3. Automated Clearing House

Automated Clearing House system is known as Electronic Clearing Service (ECS) in India.
With the introduction of National Electronic Clearing Service (NECS) by RBI, a centralized service, the
reach of the system has further deepened and all the identified core banking branches of banks are
participating in the system irrespective of whether it is located at the listed ECS centres.
NPCI proposes to build, implement and manage an Automated Clearing House (ACH) system with
built-in security features and multiple level data validation facility accessible to all participants across
the country. The new centralized ACH solution is expected to consolidate the current multiple ECS
systems in due course of time and provide framework for removal of local barriers / inhibitors and
harmonization of standards and practices.

ACH platform will have national footprint which will cover 82000+ bank branches. The platform will be
robust, secure and scalable with both transaction and file based transaction processing capabilities. It
will have best in class security features, cost efficiency & payment performance (STP) for all
participants.

4. AADHAR Payment Bridge System ( APBS )

A centralised electronic benefit transfer system to undertake direct mandates from respective sponsor
or accredited bank attached to various government departments for the purpose of disbursing
entitlements using Aadhaar numbers. Features :

- Pre supposes that all Government beneficiaries would have Aadhaar linked account number
- Government Department can send file containing IIN, Aadhaar No and Amount
- APBS will receive the disbursal payment instruction from the Government Departments through
Sponsor Bank – (Banks has ability to convert in the required format)
- The bank identifier would be used to route transaction to the destination bank – the destination bank
will maintain the linkage to Aadhaar number and bank account for seamless credit to customer account
- Enriched MIS to participants
- Secure Clearing and Settlement
Almost 20cr new consumers into the system now….
( II ) Other Enablers

 SUVIDHA Case- Study :: Cash-convertor

Funded by Shapoor Pallon ji, Northwest Venture, Reliance Venture, IFC & Mitsui.
Pioneer in S-Commerce , it aggregates , commoditize and distributes services via Non-Banking
channel. Works akind to Telecom's pre-paid model by accepting cash against any service that the
consumer wants. It currently has 50k outlets across 2000 cities. It has tie-up for Ticketing ( Rail, Air
& Bus ) , Telecom , Insurers , Banks & Any kind of bill payments.

 A-Little-World Case Study :: Banking Enabler

Funded by SBI-ENAM & others
Is a popular end-to-end technology driven platform for branchless banking - based on Mobile ,
Electronic RFID's & Biometric cards. Enables banking & other financial services reach the un-
banked, which is otherwise unfeasible for the institutions to provide directly. The co. has helped SBI
acquire 60lac no-frills account thru 10000 micro-branches which operate out of individuals or
grocery shops. In next 3 years , SBI is likely to reach 12000 villages thru 25000 such micro-branches.

 Financial Information Network and Operations Limited (FINO )

Investors - HSBC , ICICI , IFC , LIC , Intel Capital , Blackstone , Union Bank , & Corp. Bank.
FINO works on national priority projects (NREGA, RSBY, SSP, etc) therefore helping reach a critical
mass to provide economy of scale to all customers. We enable sourcing and acquiring of micro
transaction customers at their doorstep. Our model is built to offer bouquet of products to clients
and their customers at affordable prices across channels as compared to traditional infrastructure
based delivery models. Has a customer base of 46m and a force of 27000 POS across 414 districts.

 Itz-Cash
Investors :: Essel Group, Matrix Partners & Lightspeed Venture.
Has an extensive pan-India network spanning over 40,000 ItzCash franchisees. Additionally there
are approx 2,00,000 outlets in 2,000 Tier I and Tier II. It has more than 8 million unique active users
and processes more than 100,000 transactions worth Rs100 mn - Rs 150 mn worth transactions daily.
It is one of the largest payment gateway on IRCTC

 Yes Bank - OBOPAY

Are launching a Mobile-Solution for virtually any payment service without the need to have a bank-
account. They will extend this to 2 lac locations.

Several others
Why Investing is the World’s Most Difficult Profession

August 26, 2012 John Standerfer

Being a professional investor is the hardest profession on the planet.

Not because the financial markets are global and 24/7. Not because the markets are full of extremely driven
and intelligent competitors. Not because the emotional highs and lows can be soul crushing. It is because
of the constant and measurable competition against passive benchmarks.

Each day, month, quarter and year a professional investor’s performance is measured against both the
benchmark and their peers. Outside of professional sports, I’m not sure there is any other industry that
generates such objective and continuous measurements. And even in sports, there is no equivalent of a
“passive benchmark”. If a player is struggling, teams do not have the option to replace that player with a
benchmark that guarantees them the averaged production of every player at that position.

Benchmarks are the most ferocious of competitors. They show up for work everyday. They never get
sick. They don’t take vacation. They are always 100% invested so their results are continuously
compounding. Most importantly, they’re not aware of their own performance. The S&P 500 will never
enter the 4th quarter feeling it needs to really press to have good numbers for the year. Nor will it take
December off to “lock in” a good year.

Not only is the pressure unrelenting, but your failures are public on a scale that again only professional
athletes can relate to. If you do become a successful professional investor and overcome all of the above,
there is always the question of skill versus luck.

No fan in their right mind believes they have a chance of beating a Kobe Bryant or LeBron James at
basketball. Yet any investor can now buy a portfolio of index funds and have a good chance to outperform
not just a few, but the majority of mutual and hedge fund managers.

This inconvenient truth is like a little voice in the head of every successful investor – “Am I really good at
this or have I just been lucky?”. A voice that never goes away as it only takes a couple bad years to destroy
an lifelong track record
 Solid Ground
Global outlook

Russell Napier Deflation in a fiat world

Turns out we don’t live in a world of fiat currencies after all. Since 2007,
two-thirds of global money-supply growth has come from emerging
markets (EMs), where authorities create money automatically as they
intervene to contain their exchange rates. Capital-account surpluses are
at least as important as current-account surpluses in driving money
creation: borrowing dollars to fund domestic assets boosts capital
inflows and monetisation. But with EM external accounts now rapidly
deteriorating, this era is over. The resultant slowdown in EMs will -
primarily through lower commodity prices - produce another
deflationary shock.
7 September 2012

Global The PBOC defeated deflation, not Bernanke

 US money-supply growth accounts for just 15% of total growth since 2007.
Macro strategy  China’s share of this growth is three times larger than America’s.
 Brazil and India’s combined share is near that of the USA.

Forced money-creation in EMs is ending

 Inflation in emerging markets is eroding their external surpluses and reducing
money creation.
 Capital-account surpluses are disappearing quickly as declining returns on capital
deter investment.
 Rising US-dollar borrowing boosted capital inflows, but now it is slowing.

Money-supply growth in the developed world is sluggish

 US money growth has slowed from 8% YoY to 5%, while Japan has zero growth.
 Europe’s money growth will fall from the current 3.5% YoY if bank lending to the
private sector continues to contract.
 If Europe’s next step towards fiscal federalism falters, the region will face a
monetary disaster.

Command-economy banks and baby boomers bring deflation

 Chinese bank credit creates money, but it also funds increased production rather
than consumption.
 Low interest rates are forcing the ageing baby-boom generation to save more, not
consume more.
 Deflation is not an outlier; and cash is king.

China’s foreign-reserve growth near zero

60
See also: (%)
50

40

30

20

10

0
97

98

99

00

01

02

03

04

05

06

07

08

09

10

11
98

99

00

01

02

03

04

05

06

07

08

09

10

11

12
Aug

Aug

Aug

Aug

Aug

Aug

Aug

Aug

Aug

Aug

Aug

Aug

Aug

Aug

Aug
Feb

Feb

Feb

Feb

Feb

Feb

Feb

Feb

Feb

Feb

Feb

Feb

Feb

Feb

Feb

www.clsa.com Source: Datastream

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor proprietary database at clsa.com
 Executive summary Solid Ground

Deflation in a fiat world

You're right, we did it. We're very sorry. But thanks to you, we won't do it
again.
Ben Bernanke to Milton Friedman about the Great Depression
on the occasion of his 90th birthday (2002)

Most money created since
2007 is not the product of
the fiat-money system
It’s generally held that in our fiat-money world, inflation is the most likely
outcome of unfettered money creation. However, in reality key global players
do not live in this world. Most emerging-market (EM) authorities allow the
quantity of money in their economies to adjust as necessary, while managing
their exchange rates relative to the US dollar. Two thirds of the growth in the
global money supply since 2007 was from these countries. A sudden
deterioration in their external accounts automatically produces a major
deceleration in money growth. Just such a slowdown is now underway.

In extremis, a commitment to defend an exchange rate combined with a

balance-of-payments deficit can result in a monetary contraction. Key EM
jurisdictions - China in particular - now face major deteriorations in their
external accounts, primarily due to capital shifts. Given their importance in
driving global money-supply growth (China alone is responsible for 40-45% of
the growth since 2007), a decline in their ability to create money is likely to
tip the world towards deflation.

EM inflation is rapidly The key driver of lower current- and capital-account surpluses in EMs is
reducing external inflation, which undermines their ability to attract and retain capital, and
surpluses and slowing
initiates the slowdown of domestic money creation and domestic growth.
money-supply growth
Undervaluing the exchange rate in nominal terms inevitably leads to inflation
and an exchange-rate revaluation in real terms. This is more insidious than a
nominal revaluation but also negatively affects competitiveness and returns
on capital. Indeed, it has a greater effect on returns, whereas the impact of a
nominal revaluation is heavily focused on the import and export sectors. With
prices rising across the economy, capital in all sectors struggles to secure
sufficient price rises to ensure that returns do not decline when a real
exchange-rate appreciation occurs. While it is possible for capital to maintain
returns in a high-inflation environment, the historical record suggests it is
likely to lose the battle.

Investors who believe capital can win need to reread Warren Buffett’s How
inflation swindles the equity investor (Fortune Vol. XCV No.5, May 1977;
reprinted in Classics: An Investor’s Anthology by The Institute of Chartered
Financial Analysts, 1989). Buffett seeks to explain why these equity claims on
real assets failed to provide the protection against inflation most analysts
expected. In particular, he notes that there was no statistical evidence to back
the proposition that corporate margins would expand in periods of inflation -
indeed, even by 1975 it was clear that margins were contracting as inflation
accelerated. The data from the Chinese listed sector show returns on capital
employed falling from 15.6% in 2007 to 10.5% today, and declines in returns
on capital are evident across EMs.

China’s capital-account This dynamic will deplete China’s capital-account surplus - a key part of its
surplus has accounted external surplus which has driven money creation. From 2007-11, China’s
for about half its
capital-account surplus accounted for around half of its total surplus. The
total surplus
mainland’s move to a capital-account deficit in 2012 and its declining foreign-
exchange reserves show that the mechanism is now in reverse. While many

7 September 2012 russell.napier@clsa.com 3

 Executive summary Solid Ground

investors watch the current account for signs of a decline in competitiveness,

capital flows are likely to demonstrate this key change in trend well before it
is apparent in the current account. As investors in EMs have learned many
times before, capital can move very quickly. What appears to be a robust
balance-of-payments situation anchored on a material current-account
surplus can quickly become a one driven by a capital-account deficit. After
many years of higher inflation in key EMs, we are close to such a tipping
point; and if the authorities respond by defending their exchange rates, a
dramatic slowdown in money creation will ensue.

In the developed world, This slowdown would come while developed-world central banks are still
central banks still struggling to create robust, sustainable growth in broad money. A fiat-money
struggle to create money
system is not one where the authorities grow money by printing it. Instead
they seek to produce expansion in the fractional reserve banking system’s
balance sheets, resulting in the creation of bank deposits. Thus under the
standard mechanism, the creation of fiat money depends primarily upon
supply and demand for bank credit and/or the willingness of banks to expand
their balance sheets through the purchase of other assets - ie, government
debt. If the authorities work only to create money through the banking
system, they will fail if the supply/demand for credit does not result in the
expansion of bank balance sheets and creation of deposits.

QE produced moderate
growth in broad money in
the USA, but not in the UK
In the USA and UK, the breakdown in the supply/demand equation for bank
credit was spotted early and the authorities began to bypass the banks by
buying assets from the private nonbanking system. This created new money
for the sellers of these assets and helped prevent a contraction in fiat money
while bank balance sheets shrank. The experiment shows that fiat money can
be created even when the normal channels are broken. However, the central
banks must work harder, as new regulations - as well as the condition of their
balance sheets - are pushing commercial-banks towards reducing rather than
expanding credit. In the UK, even the creation of money outside the banking
system via QE failed: broad money has declined by £324bn (9%) since early
2010. The USA’s QE has been more productive. US M3 (as reconstituted by
CLSA) has expanded by US$1,229bn (12%) from its April 2010 low but is still
just 7% above its 2009 peak, whereas the UK’s M4 is 7% below its 2011
peak. If this monetary experiment is to be the cauldron of inflation, it has yet
to produce the head of steam for higher prices.

European bank loans to In Europe broad money is growing at around 3.5% pa, but this looks set to
the private sector are fall as lending to the private sector is contracting. Only strong growth in bank
contracting and the risk
credit to European governments is preventing a decline in broad money. The
of a euro exit is rising
Eurozone thus finds itself in a precarious situation: the last time bank loans to
the private sector contracted, a reduction in broad money and a recession
ensued. Draghi may be able to move forward with a form of QE, but it is
unlikely to boost broad-money growth in the near term. US broad money
declined for a year post QE1, and UK broad money is still contracting despite
particularly aggressive QE. The ECB will have an even harder struggle if any
Eurozone member fails to take the next step to fiscal federalism and has to
leave the euro. In this situation Europe could face a major monetary disaster.
Whatever the region’s monetary future may be, the least likely outcome is
acceleration in broad-money growth.

China’s banks do create
money, but in the process
they also finance the
production of capacity
Most of the world’s money-supply growth now springs from China, which may
undermine some of the inflationary implications of such growth. The PBOC is
unlikely to resort to creating money outside the banking system while it

4 russell.napier@clsa.com 7 September 2012

 Executive summary Solid Ground

controls the lenders as well as most of the borrowers. However, a huge

downside to placing the wellspring of global money creation in a command-
economy system is that the expansion of bank credit produces ever-higher
levels of investment and production.

An investment-heavy Whereas in a commercial system, bank credit expansion is market-driven and

expansion is less market forces decide how borrowed funds are split between investment and
inflationary than one
consumption, the bulk of lending in China is committed to investment. As
heavy on consumption
long as investment-led binges are at the core of Chinese banking and
monetary expansion, it is dangerous to assert that its role in creating money
adds to global inflationary pressure. Money expansion in China can produce
inflation in factors in short supply, such as labour. But given that the other
side of money creation is further investment, it can generate deflationary
pressure in other areas. This particular form of bank credit and money
expansion may also reduce the country’s attractiveness to capital. Rising
labour costs and overinvestment are exactly the factors that can depress
returns. Thus a rapid expansion in Chinese money comes with a
disproportionate amount of investment and production and also ultimately
weakens the capital account. There is already evidence that this is happening:
high wage growth has produced no export inflation, and the country has
moved to a capital-account deficit.

Avoiding 1997-98, 2000- Deflation is very unlikely in a fiat system. However, the world does not
03 and 2007-09 deflation operate on such a system. The EM money supply is anchored on exchange-
shocks was key . . .
rate targeting, not money-supply targeting. This restricts monetary freedom
at a time when the developed world is struggling to increase the supply of fiat
money due to the banking crisis. Crucially, in China the ability to create
money is predicated on the command-economy banking system’s ability to
continue funding ever higher levels of investment and production. This
combination of factors is now aligned to make a deflationary adjustment more
likely than an inflationary adjustment. While the grossly over-indebted
nations will eventually have to inflate their way into the future, the path to
that inflation is not straight. Deflation delivered three damaging losses of
capital to investors in 1997-98, 2000-03 and 2007-09. Investors who opted
. . . and now it’s time to for liquidity during these episodes generated material real returns in equities
avoid the next one over 1997-2012 and produced at least top-decile performance relative to the
competition. Avoiding the next deflationary episode is now key not just to
profiting but perhaps even surviving as a professional investor.

China, not Bernanke, Largest economies’ contribution to money-supply growth

was the key driver (%) Local-currency terms US$ terms
of inflation USA 15 10
Eurozone 6 10
Japan 1 25
UK 5 (1)
China 45 40
Russia 3 1
Brazil 7 4
India 6 2
Mexico 3 2
Korea 1 0
Indonesia 0 0
Turkey 2 0
Australia 3 3
Canada 3 2
Switzerland 1 1
Saudi Arabia 1 1
Source: Datastream, CLSA Asia-Pacific Markets

7 September 2012 russell.napier@clsa.com 5

 Excerpts from ‘ Black Swans thesis of energy transformation ‘
By Vinod Khosla, Khosla Ventures

Introduction

The looming twin challenges of climate change and energy production are too big to be tac
kled by known solutions and time honoured traditions. Incremental
remedies are fine for incremental problems, but they are insufficient for monumental, potentially
life--‐altering threats, which need to be approached with a disruptive mind-set.
There are 5 billion people coveting the energy--‐rich lifestyles currently enjoyed by
500 million people, mostly in the developed world. Incremental technology progress
will not satisfy this craving. We need non--‐linear jumps in technologies. Technological Black
Swans! We can invent these future technologies.

Environmentalists have done a superb job identifying the problem, but often push impractical id
ealistic solutions at high cost or inconvenience to consumers. I believe that capitalism and selfi
nterest driven models of new technology adoption are the lowest risk way to achieve a low carb
on social infrastructure and plentiful energy. The solution cannot be pushed by legislation or go
vernments; it must be pulled into the market by consumers, corporations and aided by en
couraging policy. The environmentalist solution is often one of “deploy the technologies we have
as quickly as possible” combined with idealized hopes that the business community will start t
o value un--‐priced environmental and health externalities.

These thoughts are noble, and occasionally work, but distract from our best “broad” hope:
robust unsubsidized market competitiveness of “green” technologies against their fossil competit
ors. This should be the mantra and goal of Black Swan technology development. After all, the
logic of business is to externalize as many costs (like using public roads or not reducing
emissions) and maximize profits, as it should be. “Green” should be a feature that follows –
rather than defies the “laws of economic gravity,” which in essence declares that economics tr
ump everything when it comes to mass adoption of a technology. In fact, the mindset of clea
n energy always costing more can be turned completely on its head in many, even most,
areas economic energy focused innovations could save consumers hundreds of billions.

My basic thesis is that investment in true innovation is the key to reinventing the infrastructure
of society and enabling 5+ billion people to sustainably live the energy affluent lifestyle that 500
million. While there is no shortage of existing technology providing incremental improvements –
whether today’s thin film solar cells, wind turbines, or lithium-ion batteries even summed, they
are not likely to address the scale of our problems. While these technologies will continue to
improve and sometimes this incremental ecosystem will result in products compliant with the laws
of economic gravity, such as wind in certain locations or lithium-ion batteries
in certain applications, I suspect this will not be enough. Regulation and clever
accounting will help many pundits justify and push these technologies, but in order to drive
the necessary resource multiplication, we need to (and can) reinvent the infrastructure of society
through the creation of Black Swan energy technologies.
These Black Swans are technologies that are market competitive without subsidies once scaled, a
and hit the CHINDIA price point (the price at which people in India and China will willingly purc
hase without subsidy) while providing sufficient scale to have measureable impact. They may
have up to a 90% chance of failure, but if they succeed, everything changes. Ironically, many
appear to have a high probability of failure mostly because they have not been given sufficient
scientific focus. Because of this, the sceptical questions such as “wasn’t this tried before ?”
or “why now?” keep many people from even trying.

Consider this: most projections of future oil use are based on linear extrapolations of the pa
st.However, the reality is quite different: for instance, as personal income (PPP GDP per capita
in 2010 dollars) in South Korea went from $10,000 per person to $20,000, over 10 years, per c
apita oil use quickly jumped from a mere 0.014 barrels per day per person to nearly 0.05,an in
crease of 3.5 times.Now consider that in 2009, China was at ~$12,500 PPP GDP per capita and
growing by at least 10 percent. If China continues to grow at 10 percent, they’ll reach the $
20,000 threshold in 5 years and $30,000 by 2020. In order for China’s oil
consumption to track South Korea, or Taiwan, the world oil output would need to dou
ble, and China would go from 10 percent of demand to nearly half.

In reality, we won’t run out of oil overnight. We can produce a lot more oil than many
pundits believe; if prices go up, oil sands, oil shale, coal-to-liquid and a handful of other
processes will scale up oil reserves are more of an economic concept than a geological one. H
owever, most of these technologies are far more costly and damaging to the ecosystem than
traditional oil extraction and have increasing costs as we try and access more of these resources.

The only way to create 5 billion energy-rich lifestyles economically without complete
environmental destruction and geopolitical conflict is through resource multipliers: technology
or techniques that dramatically increase our ability to create and use energy efficiently. More
specifically, the technology will have to achieve 5 to 10 times our current energy productivity (
GDP output per BTU consumed or 80 to 90 percent improvement in efficiency overall) over the
next few decades while dropping carbon emissions per unit energy by a similar factor, by
increasing supplies of economic low carbon energy (BTU per carbon emissions). In simple ter
ms, we need more light per unit of electricity and lower carbon per unit of electricity, more
engine horsepower per gallon of fuel and lower carbon fuel, etc. (I have written about how bes
t to structure a global carbon framework previously in my paper “Whose Rules?” and a
recent foreign policy article.)

Focusing on shortterm incremental solutions as the answer risks distracting us from working on
the home runs that could change assumptions. This is the real danger because only when we bre
ak down current assumptions can we begin to confidently look for those game changers
. Incremental improvements have their place as part of a complex ecosystem of innovation,
but mostly as catalysts to larger innovations that end up changing assumption.

Therefore, I personally believe we overvalue incremental steps at the expense of Black Swan
innovations that have a better shot at economically addressing problems at scale. As an
example, wind power makes economic sense in certain applications but will remain a niche
solution until energy storage takes a quantum leap. A Black Swan in storage would change
the outcome for wind (and solar) more than any innovation in wind, which is why I think
that subsidy dollars are better spent encouraging storage innovation than wind adoption.

Solar, given the current trajectory and rate of technology innovation, may get substantially more
economic through technology change into the adjacent possible. While the adjacent possible in
wind is generally incremental, in solar, if one defines the adjacent possible to include structures
and materials different than traditional solar cells, then large improvements are possible. Though
often a matter of definition and semantics, “incremental” upgrades and tweaks to most current
technology merely reinforce the erroneous generalized belief that “everything” has already
been “ figured out,” and tomorrow’s solution is simply today’s technology with a few tweaks.

That said, uneconomic solutions simply will not succeed at scale. The only scalable solutions
are economic ones that hit the “CHINDIA” price point. After all, a rural Indian farmer
won’t buy a more efficient widget because it emits less carbon; he’ll buy it because it save
s him money, or enables him to do something he couldn’t do previously. Remember that
this farmer doesn’t have access to cheap credit, which many environmental or academic “eco
nomic” calculations assume to be a 3 to 5 percent interest rate, but rather he borrows at
the rate of the local moneylender.

Any new technology must have a path to unsubsidized market competitiveness if it’s going to h
ave a chance to scale. To have any hope of rapid adoption, this new technology must pay for
itself in a year or two for individuals or have at least an 18 to 20 percent IRR for corporate i
nvestments. This is the reality of consumer and corporate behaviour against all the arguments
of what consumers or corporations “should” do.

Nuclear is a classic example of an incumbent technology that claims to be cheap, but this
illusion swiftly breaks down without government loan guarantees (capital cost subsidies), waste
disposal subsidies, subsidized insurance and the like. If solar, wind, storage and other technologi
es were on a level playing field and got similar loan guarantees and similar subsidies
i would welcome the competition. The fact is that the nuclear industry received tens of billions
in cumulative subsides when it was nascent to get down the cost and technology curve, and still
continues to do so. Much of the miracle of France’s nuclear power could not be replicated today at
the 12-15% return rates commercial investors want. Nuclear power in those “level playing field
“conditions would not be the cheapest alternative, though I am a fan of letting nuclear power
compete with renewables.

Wind and solar for their part need to recognize that we cannot supply power only when the wi
nd is blowing or the sun is shining, but when the consumers want it! Averaging renewable re
sources over large areas doesn’t get there since it works only in an idealized situation with e
nough sources, but not along the path of development, and power needs to be delivered al
most 100 percent of the time it is demanded. We need to be pragmatic on all sides; reliable pe
ak power matters. It is difficult to have policy biased towards innovation, or “innovation capita
lism,” but it will help assuming it can get past the existing influencers. Havinggood policy inpla
ce will help, but again, in my view, it is not necessary to drive Black Swan innovations in the
US.
 Energy is an even bigger challenge and opportunity than information and telecommunications.
Market forces will drive reinvention of the infrastructure of society. If we harness and motiv
ate these bright new minds with the right market signals, a whole new set of future assumpti
ons, unimaginable today, will be tomorrow’s conventional wisdom. I predict there will be 10
or more Googles in the energy space in the next two decades.

The KV “clean dozen” “shots on goal”

What if oil was renewable and cheaper than fossil crude oil and we used 50--‐65% less of it?

1. KiOR (www.kior.com):
KiOR is a renewable fuels producer taking wood chips, whole logs, agriculture
and other lignocellulose material and converting it directly into a crude oil or gasoline
and diesel blendstock that can be “dropped in” to the existing refinery or distribution
infrastructure without significant modification. The company combines a proprietary catalyst
system with an oil industry process called FCC (a proven industry for 60 years). In essence,
KiOR’s technology simply reduces nature’s process of creating oil from biomass by removing
oxygen that usually takes millions of years to a matter of seconds .Aiming $60/ 80 per bbl costs.

2. Ecomotors (www.ecomotors.com):
Ecomotors is a company reinventing the internal combustion engine, which is one of the
relatively inefficient, yet most used devices in the world today. Can yield up to 50 percent more
efficient powertrains in dual module configurations at costs substantially lower than hybrid drive
trains. The advantages of the OPOC design are in its relative simplicity (fewer parts), low cost,
lighter weight, and higher power density.

What if coal based electricity could be 75% cleaner and we used 75% less of it for lighting and c
ooling?

3. Ciris (www.cirisenergy.com):
The world depends on coal for a substantial portion of its energy supply. While replacing coal
is a legitimate long term goal, what if we could clean up coal without enormous costs associated
with unproven IGCC? Ciris Energy is working on turning underground seams of coal into
natural gas producing wells (30% reduction in emissions) without the financial costs and
environmental degradation of traditional coal mining and burning. Ciris aims to render old--‐
fashioned coal mining obsolete.
4. Calera (www.calera.com):

What if carbon dioxide wasn’t an environmental problem, but rather

feedstock? Using carbon dioxide, waste alkalinity and brines, Calera’s technology is attempting
to produce cement and building materials from the captured emissions. The company has
developed new electrochemistry to enable the process and is attempting to overcome process
cost – a task made more challenging in the absence of a material carbon price.

5. Terrapower (www.terrapower.com):

Terra Power’s traveling wave reactor (TWR) will offer a path to zero--‐emission, proliferation--‐
resistant energy that produces significantly smaller amounts
of nuclear waste than conventional nuclear reactors. After an initial start--‐
up with a small amount of low--‐
enriched material, this innovative reactor design can run for decades on depleted uranium –
currently a waste by
product of the enrichment process (or even spent fuel from other reactors). An
established fleet of TWRs could operate without enrichment or reprocessing for millennia.

6. Soraa (www.soraa.com):
Soraa is developing high quality LED lighting at low cost they expect to be able to sell an LED
bulb with 80% less energy consumption than standard incandescent lamps with the same light
output and with a 12 month payback. These lamps can be designed for any form factor able t
o fit standard residential and business light fixtures while offering significant energy savings

7. Caitin (www.caitin.com):
HVAC (heating, ventilating, and air conditioning) systems the world over generally use the
same approaches.
These existing cycles have been pushed to their limits in terms of performance and efficiency
gains with little innovation to be had. Caitin is in the early stages of exploring a completely
different approach --‐ compressor-
less cooling that exploits a whole new thermodynamic cycle (the first practical new thermodyna
mic cycle in over 50 years). If the system works as envisioned, they aim to provide very
efficient cooling (coefficient of performance of 6-10 ) , 2x better than
state of the art compressors with an extremely short payback period and independent of local c
onditions like humidity.
 What if electricity storage was affordable for both stationary and mobile applications and we
had a truly smart grid, well beyond today’s “smart meters” that are little more than automa
ted meter reading?

8. Lightsail (www.lightsailenergy.com):

To be truly “dispatchable” and available to match demand, power generation needs the ability to
have efficient and cheap energy storage. Lightsail is exploring highly efficient and cost effective
compressed air energy storage (CAES) technology with return trip storage efficiencies upwards
of 75 percent. They believe they can get to power costs of less than $500 per KW and energy
costs of below $100 per kWh, without the need for underground caverns (geographically constrain
ed), without needing to use natural gas for power regeneration as is current practice, and without
the large energy losses and huge footprints that experts assume for CAES.

9. Quantum Scape/ Ultra--‐

advanced electrical energy storage: Exotic physics instead of electrochemistry to provide in
expensive and very dense energy storage. Meanwhile revolutionary power electronics could
help transform storage integration and the electric grid.

Other interesting technologies:

Multiple other technologies are interesting as well, including Gen IV solar cells, small modula
r nuclear reactors, methane hydrates mining, high voltage DC transmission, electrochromic wind
ows, new construction materials, thermoelectrics, bioplastics, waste utilization, solid oxide fuel
cells, or other high efficiency distributed power generation and hundreds of other technologies t
hat I consider important though not all are Black Swan “shots on goal.” And there are technolog
ies we desperately need like a Black Swan for water desalination.
CANVAS OF MY WORLD

www.devdutt.com | By Devdutt Pattnaik, Chief Belief Office – Future Group.

One day, the two brothers, Ganesha and Kartikeya, decided to race three
times around the world. Kartikeya, being more athletic, jumped on his
peacock and flew around the oceans, the continents and the stars. The
elephant-headed Ganesha simply went around his parents, twirling
around himself, and declared himself the winner. When asked for an
explanation, Ganesha said, “I went around my world. You went around
the world. What matters more?”

The world is objective; truth independent of human imagination. My

world is subjective; truth dependent on human imagination. Different
people of the world imagine the world differently.

Greeks believed you live only once. And the one who does something extraordinary in this life , earns
oneself a place in Elysium, the heaven of heroes. In the Greek world, the gods of Olympus were capricious;
they sought to keep humans in check lest they rise up in revolt. They feared being overthrown by humans
just as they had overthrown the Titans and the Titans had overthrown the Giants before them. Heroes were
men who did extraordinary things despite the odds thrown in their direction by the Fates controlled by the
gods. Epics spoke of fathers who tried to kill their newborn sons who were prophesized to kill them, and of
sons who rose up against father and god and authority, fought the monsters created by them, and after
many an adventure, achieved the impossible to become heroes, worthy of adoration. Glory lay in defiance
of authority and transgression of rules. This is the recurrent theme in the stories of Hercules, Theseus, Jason
or Achilles.

The Abrahamic faiths (Judaism, Christianity, Islam) also speak of one life, followed by an afterlife. But the
world imagined by them is very different from the one of the Greeks. The Biblical world referred to a kind
and loving God who cared for his creation and whose children kept breaking the rules he asked them to
follow. So we have the story of the transgression of Adam and Eve, and of various prophets like Moses and
kings like David, who struggle to uphold the commandments of God, and make others follow them in
faith. Glory here lay in obedience and compliance; it gets you not to Elysium of the heroes but to what the
Koran refers to as Jannat for the faithful.

Who is right? Should life be about defiance or compliance, about breaking rules or following rules? If the
question was posed to a Rishi from India, he would ask: why should the answer be this or that, why can the
answer not be this and that. He would say both are okay depending on the context. So Hindu mythology
has Krishna who breaks rules and Ram who follows rules. Krishna belongs to Dvapara yuga and Ram
belongs to Treta yuga. But are not Krishna and Ram two different characters? Not at all, said the Rishi; they
were two lifetimes of Vishnu, who is God.
The Rishi believed in rebirth. He believed we do not live just one life; we live infinite lives, one life after
another, again and again. Death is not a full stop; it is a comma. And so you have the option of living one
life in defiance and one life in compliance depending on whether the father, or authority, or deity, of that
life is cruel (like Olympian gods) or caring (like God of Abraham). This view is shared by most religions of
Indian origin, including Jainism and Buddhism.

Refusal to acknowledge these imagined realities, these ‘my’ worlds, is the root cause of cultural intolerance,
human insensitivity and the clash of civilizations. It happened once nearly 2300 years ago on the banks of
the river Indus. Alexander, the Great, after conquering Persia found there, what he called a gymnosophist,
or a naked wise man. He was perhaps a Jain muni or perhaps a yogi, who sat on a rock and meditated all
day and gazed at the stars all night. “What are you doing?” asked Alexander. “Experiencing nothingness,”
answered the gymnosophist. Then the gymnosophist asked, “What are you doing?” Alexander replied, “I
am conquering the world.” Both chuckled and parted ways, each one thinking the other was a fool.

For Alexander, the denominator of life is only one; so the

value of his existence was the sum total of our
achievements. So conquering the world was important to
him. For the gymnosophist, the denominator of life is
infinity; so the value of his existence – no matter what he
did – was zero. So reflecting on the world and seeking its
meaning by ‘experiencing nothingness’ was important to
him. So who is right: Alexander or the gymnosophist? What
is right: one life or rebirth? Intolerance stems from valuing
one imagined reality over the other.

Significantly, science in its quest for the objective truth aligns itself with one-life subjective truths. But
which one? Greek or Abrahamic? Alexander’s subjective truth works for those who want to conquer the
world. But there are many who are not interested.
 www.khanacademy.org

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