Traders said position cutting ahead of Friday's $2.7 billion bond sale was also prompting investors to sell debt.
Total volumes on the central bank's electronic trading platform were at a moderate 49.85 billion rupees ($1.1 billion).
"Buy on dips in the strategy. There is a clear turnaround in sentiment since last week. Reasons could be expectations of lower crude, industrial output, inflation, lower growth, etc.," said Anoop Verma, an associate vice president with Development Credit Bank.
"Probability of a rate hike in June is also low, otherwise it could be the last," he added.
The government has again deferred a decision on raising prices of diesel, kerosene and cooking gas, needed to rein in the fiscal gap, sources said on Wednesday, as it deals with one of the worst political crises in recent years.
Weekly food and fuel inflation data expected around noon (0630 GMT) will be watched for direction.
Traders could also take profits after Wednesday's rally, and ahead of the auction on Friday.
Yields and swap rates fell sharply in late trade on Wednesday as short-covering was triggered on speculation the central bank may hold off raising rates at its June 16 policy review.
"Rise in oil prices is hurting a bit," said Chetan Shenoy, an associate vice president at IndusInd Bank.
Brent crude rose to $118 on Thursday after Saudi Arabia failed to convince OPEC to raise output targets, and data showed US crude stocks fell sharply last week.
India imports more than three-quarters of the oil it consumes and higher prices will have an impact on the country's fiscal deficit.
Traders said a rise in US yields also hurt sentiment. The benchmark US 10-year notes yield was trading at 2.96 percent in Asia from 2.93 percent on Wednesday.
"There is some receiving in OIS (overnight indexed swaps), guess the market is betting on a no rate hike scenario," IndusInd's Shenoy said.
The benchmark five-year swap rate was down 2 bps at 7.79 percent, while the one-year rate shed 1 bp at 7.87 percent.
Copyright Reuters, 2011