Life @ 8.

5% G-sec yields

Private and Confidential. Only for distributors and advisors of ICICI Prudential Mutual Fund



While equity markets are scoring new highs, debt market is mutely building all that is required for
unwinding of a structural rally. Major politico-economic improvements have led to the rally in
Indian equity, though not in debt. This has resulted from the concerns on overhang of gilt supply,
possible fiscal slippage in India and an impending rate hike in the US. However, macroeconomic
improvement and fiscal prudence could bring down interest rates over the next 2 to 3 years.

We pen down five factors that are building a strong case for a structural rally in debt markets.

Improving Current Account Balance: The trend in the current account deficit has shown
considerable improvement since 2H2013, with full year FY2014 CAD narrowing to 1.7% of GDP
from 4.8% of GDP in the previous year. Current Account Deficit has a strong correlation with
interest rates in the economy. Several countries including India have witnessed sharp interest rate
rally preceded by improvement in current account balance.





The encircled area in the above charts displays strong correlation between Current Account and
Interest Rates.

Inflation: Link between inflation and interest rates is straight forward, higher inflation lowers real
returns on government securities, leading to demand for higher nominal yields. Similarly, in a
falling-inflation scenario, as we are now experiencing in India, debt-market yields are likely to
soften. Slow MSP hike-led food price disinflation, better alignment of petroleum product and
electricity prices with costs, softer global commodity price outlook, stable rupee and anchoring
of inflationary expectations due to RBIs past tightening could substantially reduce trend inflation
in India.


4.00
5.00
6.00
7.00
8.00
9.00
10.00
(5.0)
(4.0)
(3.0)
(2.0)
(1.0)
0.0
1.0
2.0
3.0
CAD/GDP (%)
10 Year Gsec (RHS)
0
1
2
3
4
5
6
7
8
-5
-4
-3
-2
-1
0
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CA/GDP%
10 Yr G-sec yield (RHS)
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
-4.00%
-3.00%
-2.00%
-1.00%
0.00%
1.00%
2.00%
3.00%
4.00%
2006 2007 2008 2009 2010 2011 2012 2013
CA/GDP%
10 Yr G-Sec Yield (RHS)
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
1
9
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1
CA/GDP%
Japan 10yr (RHS)
INDONESIA
JAPAN
INDIA ITALY


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Fiscal Consolidation: Government has set the fiscal-deficit target for this financial year at 4.1% of
GDP, and indicated that it would be slashed to 3% over the next three years. The commitment of
the central government towards fiscal consolidation is encouraging. If realised, the proposed
reduction of the fiscal deficit could be a huge tailwind for the Indian bond market. Rationalising
subsidies and revenue expenditure shall help abate inflationary pressures and will be a structural
driver behind subsiding inflation.

The improved economic outlook, better tax administration and broad-basing of taxes, especially
the services tax, are likely to increase India Tax to GDP ratio. Acceleration of real GDP growth,
therefore, can considerably aid Indias fiscal consolidation. An early introduction of the goods
and services tax (GST) could aid the process considerably.





Savings rate: After declining from its peak in 2007, savings rate is set to rise in coming years.
Helped by lower inflation, real
interest rates have inched towards
positive territory after a long
period. Increasing savings rate will
boost bank deposit growth that
may lead to fall in deposit and
lending rates. Savings rate has
negative correlation with interest
rates, a rise in savings rate shall
Inflationary expectations sliding Strong link between MSPs & food inflation
Tax to GDP ratio increasing
Subsidies on decline
20.0
30.0
1
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Savings Rate
Revenue on the rise while expenditures are falling


Life @ 8.5% G-sec yields

Private and Confidential. Only for distributors and advisors of ICICI Prudential Mutual Fund


actuate a fall in interest rates over a period of time. During 2000 2004, a sharp rise in savings led
to a sustained fall in interest rates.

Liquidity: India is undergoing a liquidity driven economic cycle with substantial FII inflows across
both local debt and equity markets. As a result, the amount the banking system needs to borrow
from the Central Bank through Liquidity Adjustment Facility (LAF) and other windows (term repos,
Marginal Standing Facility or MSF) has declined, reaching near zero. The improvement in Liquidity
is structural and not RBI infused, this may help keep overall yield curve in check and bond yields
at lower levels.





Our View: We believe that debt valuations are extremely attractive but investor sentiments are
bad. Moreover, flows into Duration funds are negative and the medium term past performance
(i.e for last 2 years) is below normal. This calls for a big buy in duration funds based on our
Valuenomics & Assetology Framework. As per the framework, the best time to invest in any asset
class is when valuations are attractive, sentiments are bleak, flows are negative and past returns
are below normal.

The Valuenomics & Assetology Framework was followed while we gave a strong buy call in
equities last September through our Value Fund series launch. This was the time when investors
were not keen to invest in equities. Similarly, investors are not investing in duration funds today
and are completely ignoring the asset class. However, we believe this may the best time to invest
in duration funds to generate above normal returns over the next 2 to 3 years.



As net liquidity switches from surplus to deficit mode and vice-versa
.. Call money moves from reverse repo to repo and vise-versa


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What do we recommend?

We strongly recommend duration funds and funds that will benefit from falling interest rates. This
may not necessarily include only income and gilt funds, but based on risk appetite investors may
choose from a wide range of our debt funds.

For conservative investors who seek to benefit from duration with minimal risk:

Investment
Horizon
Fund About The Fund
6 months to 1
year
ICICI Prudential Short
Term Plan
Aims to generate accrual income from the interest
rates prevailing in the economy. In addition, seeks
to derive benefit from any potential mark-to-
market returns by tactical, calibrated and
opportunistic approach to Government Securities
18 months and
above
ICICI Prudential Regular
Savings Fund
Aims to generate returns mainly in the form of
accrual income and also through potential capital
appreciation as it holds papers with moderate
duration.
3 years and
above
ICICI Prudential
Corporate Bond Fund
The Fund aims to generate returns mainly in the
form of accrual income and also through potential
capital appreciation as it predominantly holds
papers up to 5 years maturity.

For aggressive investors who seek to benefit maximum from duration play and have appetite to
absorb near term volatility:

Investment
Horizon
Fund About The Fund
2 years and
above
ICICI Prudential Income
Plan
The Fund seeks to actively manage the duration
or interest rate risk with a view to take potential
advantage of changes in interest rate cycles.
3 years and
above
ICICI Prudential Long Term
Plan
The Fund seeks to actively manage the duration
in 1- 10 years based on in-house model to take
potential advantage of changes in interest rate
cycles.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Data Source: Bloomberg
Disclaimer:
Nothing contained in this document shall be construed to be an investment advise or an assurance of the benefits of investing in the any of the Schemes
of ICICI Prudential Mutual Fund (the Mutual Fund). The information contained herein is only for the reading/understanding of the registered
Advisors/Distributors. All data/information used in the preparation of this material is specific to a time and may or may not be relevant in future post
issuance of this material. ICICI Prudential Asset Management Company Limited (the AMC) takes no responsibility of updating any data/information in this
material from time to time. The AMC (including its affiliates), the Mutual Fund, ICICI Prudential Trust Limited and any of its officers, directors, personnel
and employees, shall not liable for any loss, damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary, consequential,
as also any loss of profit in any way arising from the use of this material in any manner. The recipient alone shall be fully responsible/are liable for any
decision taken on this material.