MUMBAI: Indian government bonds fell for a second session on Tuesday, with yields surging to their highest in a week on fears the central bank may further tighten liquidity to prop up the rupee.
Volumes in the bond market have dropped sharply as dealers prefer to stay on the sidelines ahead of the Reserve Bank of India's monetary policy review on July 30, with no clarity yet on the bank's stance.
The central bank's sudden steps last week to stabilise the rupee has roiled bond and rates markets with yields surging across the curve.
Last Monday, the RBI raised the Marginal Standing Facility rate and Bank Rate each by 200 basis points to 10.25 percent, capped the amount up to which banks can borrow or lend under its daily liquidity window and announced a sale of government securities through an OMO.
Banks' borrowing from the central bank continued to be within manageable limits at 504.75 billion rupees, below the central bank's 750 billion rupees daily cap as lenders over-covered ahead of the implementation of the measures.
Dealers are watching if the central bank announces an open market sale of bonds this week to further drain cash.
"I believe liquidity will improve gradually on the back of falling credit demand and decent deposit mobilisation," said Kush Sonigara, research analyst-fixed income at My Capital Solutions Pvt Ltd.
"However, we believe if RBI continues to tighten liquidity then probably CRR hike may be their first preference."
The benchmark 10-year bond yield rose 8 basis points on the day to 8.17 percent, its highest since July 16. Volumes were at a paltry 129.15 billion rupees.
Trading bands were doubled in the session. Yields are already up 23 bps so far this week.
Bonds drew little comfort from the successful sale of debt investment quotas at an auction to foreign investors after prices were set very low, as analysts expressed doubt about how much in actual investments the country would attract given the lack of clarity about the central bank's policy intentions.
The near-end interest rate swap rose more than the longer-end with the negative spread widening to 71 basis points.
The benchmark five-year OIS rate closed up 8 bps at 8.18 percent and the one-year rate rose 13 bps to 8.89 percent.
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