* Govt will not lower withholding tax on federal bonds-official
* Comments come after limit auction sees muted response from FIIs
* Improved liquidity conditions help support bond prices
By Subhadip Sircar
MUMBAI, July 5 (Reuters) - Indian federal bond yields rose on Thursday on waning hopes for lower withholding taxes for foreign investors, on a session already marked by disappointment after an auction of debt limits for overseas participants attracted only tepid demand.
An auction of unused debt limits for foreign institutional investors late on Wednesday was under-subscribed, reflecting a lack of interest that analysts attributed to lock in periods that reduced the appeal of government debt.
Bonds were further hurt after a senior finance ministry official said on Thursday the government has no plan to reduce the withholding tax for foreign investors buying government bonds, saying demand for these bonds was "strong."
"The poor FII response was expected as the category was not attractive. There is no great trigger for the bond market, and I expect the benchmark paper to trade in the 8-8.25 percent band," said Killol Pandya, head of fixed income at Daiwa Mutual Fund.
The benchmark 10-year bond rose 2 basis points to 8.18 percent, while the previous 10-year bond closed up 1 basis point at 8.34 percent.
The most traded 9.15 percent 2024 bond also settled up 1 basis points at 8.39 percent.
Though Indian domestic bond markets remain mainly domestically-driven, some investors have been hoping the government would seek to attract more foreign investments.
Previous auctions have showed the strongest interest in government bonds, though some of the appeal is believed to be hampered by lock-in periods for some types of federal debt and a tax rate of around 20 percent for securities owned by non-residents.
Despite the disappointment, bond prices could see some support should liquidity conditions continue to improve.
Repo borrowings from the central bank's window dropped to 146.60 billion rupees, the lowest in 9 months.
Dealers however the sharp fall was primarily due to banks having more than met their short-term funding requirements, saying the cash deficit could rise to closer to 500 billion rupees. Still, those levels would be well below levels of over 1 trillion rupees in June.
Meanwhile, the one-year OIS rate closed down 3 basis points at 7.76 percent, while the five-year rate closed steady at 7.21 percent. (Editing by Rafael Nam)