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 MUMBAI: Indian federal bond yields tumbled on Thursday, a day after the central bank said it would buy back bonds worth up to $2 billion from the market in an attempt to ease the current cash crunch in the banking system.

After the market closed on Wednesday, the Reserve Bank of India said it would conduct open market operations (OMOs) on Nov. 24. Details of the papers are awaited.

The decision is expected to cool a spike in yields that has raised the government's borrowing costs, and traders expect more such bond buybacks in coming weeks.

"Our estimate is that the RBI is likely to purchase about 300 billion rupees via OMOs before end-December and cumulatively close to 1 trillion rupees by March 2012," Kumar Rachapudi, a fixed income strategist with Barclays Capital wrote in a note.

At 10:45 a.m. (0515 GMT), the most-traded 10-year bond yield was down 7 basis points at 8.81 percent. It has traded in a range of 8.77 to 8.80 percent so far in the day.

At Wednesday's close, the old 10-year benchmark bond had risen 63 basis points since the government announced its second half borrowing plan in end-September.

Total volume on the central bank's electronic trading platform was higher at 53.10 billion rupees ($1 billion) compared to the 35 billion to 45 billion rupees normally dealt in the first two hours of trade.

"Today's fall in yields is a short-term phenomenon. The support range for the 10-year bond will be around 8.75 to 8.85 percent for the rest of the fiscal year," said Shakti Satapathy, a fixed income strategist with A. K. Capital.

Large scheduled borrowing by the government as well as issues of unplanned short-term bills have drained cash from banks, leaving them in a tight spot. Traders said sustained supplies will continue to weigh on the market.

The government is selling 130 billion rupees ($2.6 billion) worth of bonds on Friday.

On Wednesday, banks had borrowed 1.04 trillion rupees from the central bank's repo window, and 1.06 trillion the day before, both nearly double the daily borrowing at the end of the first week of November, reflecting the extent of cash squeeze.

Central bank officials have said that they would not hold OMOs to cool bond yields, but as a tool to manage liquidity. However, past experiences have shown, yields do ease on such moves.

Traders are also awaiting any plans to raise foreign institutional investment (FII) limits in government debt. The market is hoping the limits are raised soon, which will help mop up the large debt supplies.

India's finance ministry is still in talks with the central bank about raising the FII limit in government debt, two finance ministry sources with direct knowledge of the matter told Reuters on Tuesday.

"We expect 10-year G-sec yields to trade in a range of 8.70 percent to 9.00 percent in the near term. If increases in FII limits are announced soon, the risks to our forecast would be biased to the downside," Barclays' Rachapudi wrote.

Traders said a fall in US yields was also helping. US Treasuries prices rose on Wednesday as stock market losses and fear Europe's debt crisis would widen fed a bid for safe-haven US government debt.

"We expect the RBI to announce more purchases of government securities (OMO) in an ad-hoc manner as the stress in inter-bank liquidity may persist given slowing capital flows alongside a current account deficit," Morgan Stanley economists wrote in a note.

The benchmark five-year swap was down 4 bps at 7.27 percent, while the one-year rate fell 2 bps to 8.11 percent.

Copyright Reuters, 2011