Bonds fell on Friday and were close to wiping out gains for the year as stop-losses got triggered on continued concerns about political instability and doubts about future interest rate cuts.
The benchmark 10-year bond yield has risen 11 basis points this week, the biggest increase since the week ended March 1 when the 2013/14 budget had broadly disappointed debt investors.
"The current selling is a mixture of instability in further fiscal reforms followed by the year-end portfolio realignment that would create space in accommodating the fresh issuance calendar," said Shakti Satapathy, a fixed income analyst at AK Capital.
The results of the open market operations by the RBI came largely in line with expectations. The Reserve Bank of India (RBI) bought 60.28 billion rupees of government bonds through open market operations (OMOs) on Friday, as against the notified 100 billion rupees.
Still, analysts expect bonds to see some support starting in April when funds typically increase allocations at the start of a new financial year, although the broader fundamental economic and fiscal outlook remains cautious.
"We are seeing position cutting from mutual funds which are seeing redemption pressures. However, the selling may last one more day and yields are likely to be capped at 8 percent," said Baljinder Singh, a bond dealer at Andhra Bank.
"We may see a small rally in April as new allocation in the next fiscal will begin."
The benchmark 10-year bond yield ended 3 basis points higher at 7.96 percent, the highest level since January 3.
Bonds are at a risk of wiping out gains for the year, with yields not far off the 8.00 percent level at the end of 2012.
Investors were widely disappointed after the central bank stuck to a cautious tone on monetary policy, despite cutting interest rates by 25 bps for a second time this year.
On top of that, a key regional ally withdrew from the ruling coalition, threatening the government's fiscal reform agenda.
The twin developments were a blow to the bond markets, given hopes for additional fiscal measures and a dovish central bank had been key reasons behind the earlier rally this year.
Despite the expected allocations from funds in April, the fundamental outlook remains cautious.
The Reserve Bank of India won't review policy until May, while the government is gearing up to borrow 3.49 trillion rupees during April-September after staying out of markets this month.
The benchmark five-year swap rate closed up 1 bp at 7.25 percent, while the one-year rate ended 1 bp lower at 7.53 percent.
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