India bonds reverse fall in last hour on short covering

Indian government bonds reversed their decline in the final trading hours on Tuesday as hopes of a recovery from current levels triggered some short covering and offset pressure from a weak state debt auction.

The 10-year bond yield ended at 6.5997%, against a previous close of 6.5967%. The yield hit 6.6571% during the day, its highest intraday level since March 20.

Yields move inversely to prices.

Indian states raised 288.92 billion rupees ($3.30 billion) through the sale of four- to 30-year bonds, about 85% of the targeted quantum.

The benchmark 10-year bond yield has risen 25 basis points over the last seven sessions through Tuesday, after Prime Minister Modi announced planned goods and services tax cuts, fuelling fears of fiscal slippage that could push the government to borrow more.

Bond traders are now calling for central bank intervention as a sharp drop in institutional buying has pushed yields higher, threatening to stall monetary transmission, according to market participants.

Some, however, don't expect a wider fiscal deficit.

"While the total borrowing amount would remain unchanged, the government is expected to adjust the maturity mix by reducing supply in long maturity bonds and increasing issuance in shorter maturities," Tata Mutual Fund strategists said in a note. This will bring down long-end yields, they added.

Adding to the pressure, lower banking system liquidity surplus has kept buyers at bay. The surplus dropped to around 1.8 trillion rupees as on August 25, its lowest level in three months.

Indian bond markets are closed on Wednesday for a local holiday.

RATES

India's overnight index swap rates continued to see paying pressure on Tuesday.

The one-year OIS rate closed at 5.5225% and the two-year OIS rate ended at 5.5050%. The liquid five-year OIS rate settled at 5.775%, more than 2 bps higher than Monday. (Reporting by Khushi Malhotra; Editing by Sonia Cheema)