Bonds rally on RBI's debt-purchase plan

By Neha Dasgupta

MUMBAI (Reuters) - The Reserve Bank of India's unexpected $1.50 billion debt-purchase announcement sent bonds rallying on Thursday, with traders saying it will relieve tight cash conditions in the banking system and signals an effort to push down yields.

The RBI late on Wednesday said it would buy bonds worth up to 100 billion rupees ($1.50 billion) via open market operations (OMO).

On Thursday, the benchmark 10-year bond yield fell as much as 6 basis points to 7.68 percent from the previous close. At 1:17 p.m., the bond yield was down 3 bps to 7.71 percent. The yield had risen to a near 3-month high of 7.79 percent on Monday.

The announcement came as the liquidity shortage in the banking system was 1 trillion rupees at the end of November, sharply up from about 680 billion rupees a month earlier.

Traders said they expected at least one more OMO purchase this month as a deadline for advance tax payments from companies is likely to squeeze cash conditions further. One analyst predicts the liquidity shortage could hit 1.4 trillion rupees.

OMOs could also help push down bond yields further ahead of a widely expected U.S. rate hike later this month.

Foreign investors last month cut their holdings of Indian government bonds by $645.53 million, the biggest amount of net selling since May. That caused a 15 basis point rise in the 10-year bond yield during November, even though the RBI cut interest rates by a larger-than-expected 50 bps on Sept. 29.

The rise in yields had raised worries that higher borrowing costs were undermining the RBI's 125 bps of repo rate cuts this year.

"Along with a liquidity view, RBI has also given a directional view on yields by announcing this OMO," said Vijay Sharma, senior executive vice-president at primary dealer PNB Gilts Ltd in New Delhi.

"However, to put confidence back into the investors as well as to see that this action produces the desired results, RBI may have to conduct one to two more OMO in December."

The rate cuts have let the RBI focus on supporting economic growth. But it held rates at its policy review on Tuesday.

Bond yields and cash conditions could determine the extent of OMOs this month, traders added. India is due to hold only two more debt auctions this year, one this week and one next week.

($1 = 66.6950 rupees)

(Editing by Rafael Nam and Richard Borsuk)