Indian bonds see best gains in 6 months; Feb supply a worry
* India's 10-yr bond yield ends at 7.91 pct, 2 bps higher
* S&P analyst says possibility of India losing investment grade rating receded
* Apr-Dec deficit 78.8 pct of budgeted full fiscal year deficit
By Subhadip Sircar
MUMBAI, Jan 31 (Reuters) - Indian government bonds fell on Thursday, but posted their biggest gains in six months in January, helped by hopes of monetary easing by the central bank and limited debt supply as the government looks to meet its fiscal deficit.
However, the outlook remains more uncertain. The Reserve Bank of India delivered a widely expected 25 basis points interest rate cut this week but adopted a more cautious tone about future easing than investors had expected.
The central bank has also made the country's current account deficit, which hit 5.4 percent of GDP in the September quarter, a factor in monetary policy, making capital flows and the implications of the government's upcoming budget on the fiscal deficit key triggers for Indian bonds.
Bond sales will also resume after the government conducted only one weekly auction this month, with 120 billion rupees of debt due to be sold on Friday.
"Traders have been trimming positions and the immediate outlook looks bearish given the supplies lined up," said Baljinder Singh, a trader with state-run Andhra Bank.
He expects the long 8.30 percent 2042 bond in Friday's auction to have a tail, which implied weak demand for the paper.
The 10-year benchmark bond yield ended at 7.91 percent, up 2 basis points (bps) from its Wednesday's close. It fell 14 bps in January, its biggest monthly decline since July and third successive month of fall, as per Thomson Reuters data.
Investors will be closely watching to see whether Finance Minister P. Chidambaram manages to stick to his fiscal deficit target of 5.3 percent in the current fiscal and shave it lower to 4.8 percent in the next as he has promised.
India's fiscal deficit during the April-December period was 4.07 trillion rupees ($76.22 billion), or 78.8 percent of the budgeted full fiscal year 2012/13 target, government data showed on Thursday.
The possibility of India losing its investment grade credit rating has receded as a result of the reform measures taken by the government since September last year, an analyst with rating agency Standard & Poor's told Reuters on Thursday.
Manmohan Singh's government has taken some bold steps in allowing state-run fuel retailers to raise diesel prices incrementally as well as clamping down on government spending to cut its bloated fiscal deficit.
Dealers are also focused on the large supply scheduled in February. The government will sell 480 billion rupees of bonds in the month, completing its scheduled fiscal borrowing of 5.7 trillion rupees.
The benchmark 5-year overnight indexed swap, an interest derivative contract which is used to guard against changes in funding costs, hovered near seven-month highs, rose 1 bp to 7.26 percent.
The 1-year overnight index swap (OIS) rate rose also 1 bp to 7.63 percent. (Editing by Anand Basu)
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