MUMBAI India's benchmark 10-year bond yield fell to an over 20-month low on Monday on quarter-end buying and as the government's move to sell more treasury bills was seen as reducing the need to sell longer-dated paper.
The 10-year yield fell for the first time in four years in 2012 after retreating 51 basis points, helped largely by the central bank's steep cuts in the cash reserve ratio and its bond purchases in open market operations.
Bond prices are likely to extend gains next year as the Reserve Bank of India (RBI) is widely expected to cut interest rates as early as January, although investors will also scrutinise the government's spending ahead of general elections in 2014.
"How much of repo cut is possible is difficult to say, but surely we would see rally in bonds. The scope of repo cut depends on how inflation plays out," said Aniruddha Iyer, assistant vice president at Quant Capital.
The 10-year benchmark bond yield fell as much as
10 basis points to 8.01 percent from Friday's close, hitting a level last seen in mid-April 2011, as per Reuters data. It closed at 8.05 percent, its biggest one-day fall in the yield since early August.
The RBI has held interest rates steady since its 50 basis point cut in April, although it has cut the CRR by 175 bps and bought bonds to reduce a persistent cash deficit in 2012.
Investors were comforted by the government's plans to sell 1.4 trillion rupees of treasury bills in the January-March quarter, which dealers said works out to a net borrowing of 160 billion rupees.
Investors had feared the government would borrow in longer-dated paper as part of any move to borrow more than its planned 5.7 trillion rupees of bonds in the current fiscal year to meet its fiscal deficit target of 5.3 percent of GDP.
India's fiscal deficit for the April-November period reached 80.4 percent of the budgeted full fiscal year target, government data showed on Monday, compared to 85.6 percent in the same period in fiscal 2011/12.
The immediate trigger for the markets in 2013 will be whether the central bank delivers a rate cut at its January 29 policy meet after saying this month its focus is shifting to managing growth.
The government has also raised the foreign fund limit for investment in government bonds by $5 billion, another positive trigger for bonds.
However, any rally could be capped should the government announce a spending-heavy populist package for fiscal 2013/14, which would raise worries of a surge in borrowing and of a potential downgrade in the country's sovereign ratings.
India's short-end 1-year rate and the long-end 5-year OIS rate were down 2 basis points each at 7.60 percent and 7.12 percent, respectively.
The 1-year rate was down 15 basis points in 2012, while the 5-year paper was up 4 basis points.
(Editing by Rafael Nam and Sunil Nair)