Heavy demand is expected in the $2.71 billion debt sale by the government on Friday, which will not only include 70 billion rupees ($1.26 billion) of a new 10-year bond, but will also mark the last auction ahead of the central bank meeting on June 18.
The Reserve Bank of India is widely expected to cut the repo rate in about a week's time, following up on its 50 basis points cut in April. Those expectations have now helped yields fall for the fourth session in five on Thursday.
Given this is the last chance to get new 10-year bond ahead of the policy meeting, at least five traders who spoke to Reuters saw the new 10-year bond pricing at 8.15 percent or below, marking what would be aggressive bidding.
"As this is auction for new benchmark, there will be a natural demand," said Vivek Rajpal, India rate strategist at Nomura in Mumbai.
He added that demand in the auction, which will also include 2018, 2030 and 2036 bonds, would also reflect how much traders are expecting rate cuts on June 18.
The yield for the existing 10-year benchmark ended down 2 basis points to 8.35 percent from Wednesday's close, after moving in a 8.33 to 8.40 band during the day.
Trading volume was 247.80 billion rupees, nearly 2.5 times the daily average.
Existing benchmark bond yields could rise on Friday ahead of the debt auction, although the expectations for strong demand for the sale also leaves markets vulnerable for a correction should that not materialise, some analysts said.
"If the cut off is below 8.15 percent, the bullishness in bonds will continue in the run-up to the policy, else the market will sell off," said Arvind Chari, debt fund manager at Quantum Asset Management.
A slump in growth in the January-March quarter, lower oil prices, and more dovish comments from a Reserve Bank of India deputy governor have raised expectations of a rate cut, sending the 10-year yield down by 17 basis points since Wednesday.
Nomura's Rajpal said China's rate cut was a reflection of central banks across the world looking to support growth, and said the RBI should be no exception.
The 1-year OIS rate ended down 4 basis points at 7.63 percent, and the 5-year OIS ended 4 basis points lower at 7.27 percent.
1-year swap rates have fallen 40 basis points since the weak Jan-March GDP data a week ago bolstered rate cut hopes, while the long end is down by 16 bps.