Bonds fall as heavy supply looms

By Subhadip Sircar

MUMBAI (Reuters) - Indian government bonds fell on Monday as worries about 530 billion rupees worth of debt and treasury bill sales this week kept investors cautious after last week's volatile trading.

The large supply comes at a time when the Reserve Bank of India's cash tightening steps have kept the overnight rate firmly lodged above the emergency funding rate of 10.25 percent, highlighting how expensive it has become to access short-term rates.

The Reserve Bank of India will sell 180 billion rupees of bonds on Friday, its biggest weekly sale during the fiscal first half ending in September.

In addition, the central bank will sell 220 billion rupees of cash management bills and 120 billion rupees of treasury bills.

Traders say the RBI could also opt to purchase additional debt via open market operations, which the central bank had done last week.

"Open market operations should decide the sentiment. If the RBI does not announce OMO purchase tomorrow, the market should sell off," said Lakshmi Iyer, head of fixed income at Kotak Mutual Fund.

The benchmark 10-year bond yield rose 8 basis points to 8.34 percent.

The yield fell 62 bps last week, its biggest fall in four-and-a-half years after surging to 9.48 percent on Tuesday.

The bond market also continues to remain hostage to the rupee's fortunes. The rupee weakened again on Monday to close at 64.30/31 to a dollar against its Friday close of 63.20/21.

Dealers said the choice of 48-day paper for cash management bills this week also dented sentiment as the maturity is longer than previous sales of such short-term debt, which will keep away liquidity for a longer time.

In the overnight indexed swap market, the benchmark five-year rate closed up 1 bp at 8.42 percent. The one-year rate ended higher 5 bps at 9.50 percent.

(Editing by Subhranshu Sahu)