By Swati Bhat
MUMBAI (Reuters) - Indian government bonds rallied for a second consecutive session on Tuesday, signalling a better year could be in store after investors this year plodded through the worst falls in debt prices since 2009.
Bond investors took a beating in 2013 as foreign funds fled markets after the central bank in July unexpectedly raised short-term interest rates to prop up a rupee that was slumping to record lows.
Persistently high inflation then forced the central bank to raise interest rates twice this year, even as economic growth continuing to languish near a decade-low, further hurting sentiment for domestic debt.
However, traders expect 2014 to be a relatively calmer year for bonds with the monetary tightening cycle likely drawing to a close if inflation continues to show signs of easing.
Foreign funds have also started buying in December, for a provisional total of $936.90 million, further raising hopes about the year ahead.
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"Bond market players will surely hope for 2014 to be a year with lower volatility. Such high level of volatility that we saw, and the continued bearishness has led to a fall in market appetite and a dry-up in volumes," said Arvind Chari, head of fixed income at Quantum Asset Management.
"There is a need for foreigners to step up and buy out some of the supply from the market. This would steady the market and can stem the rise in yields," he added.
The benchmark 10-year bond yield closed down 4 basis points at 8.82 percent.
For the year, the benchmark yield rose 81 bps, its biggest annual rise since 2009, having moved in a wide range of 7.31 percent to 9.48 percent during the year.
Foreign funds have been net sellers of nearly $8 billion in 2013, excluding the last two trading days of the year, after having bought $6.6 billion in 2012.
Key events lurk ahead, starting with inflation indicators in mid-January that could determine whether the Reserve Bank of India resumes raising interest rates after staying on hold this month.
Investors are also keenly watching how much the government will cut spending to meet its fiscal deficit target of 4.8 percent of gross domestic product for the year ending in March.
India's fiscal deficit touched 5.1 trillion rupees during April-November, or 93.9 percent of the full-year target, government data showed on Tuesday.
Further out, investors are bracing for critical elections due by May, as any new government will have to tackle structural challenges such as a persistently high current account deficit.
In the overnight indexed swap market, the benchmark 5-year OIS rate closed down 3 bps at 8.41 percent while the 1-year rate fell 4 bps to 8.45 percent.
For the year, the rates were up 129 bps and 85 bps respectively.
(Editing by Sunil Nair)