By Swati Bhat and Subhadip Sircar
MUMBAI (Reuters) - Indian government bond yields jumped the most in four-and-a-half years and overnight indexed swap rates posted their biggest rise in at least 13 years after the central bank curbed liquidity in a bid to shore up the struggling rupee.
Yet, the rupee gained only 1 percent on the day, sparking concern that the unexpected Reserve Bank of India measures, announced late on Monday, did not address fundamental issues behind the currency's fall and would inflict too much pain for limited gain.
India's record current account deficit has been a key reason behind the rupee's fall, and analysts say the government would need to pass measures that will attract foreign direct investments or raise funds via an overseas bond.
Although the Reserve Bank of India is still expected to keep interest rates on hold at its policy review on July 30, some analysts said the prospects of a rate hike will increase should the latest measures fail to support the rupee.
"What the RBI and government needs to do to turn the rupee's tide is a large action to draw in inflows like an NRI bond issue which will bring in $10-$15 billion," said Subramanian Sharma, director at Greenback Forex.
The partially convertible rupee closed at 59.31/32 per dollar, after rising to 59.14 in early deals, its highest since July 1.
The benchmark 10-year bond yield surged 52 basis points to close at 8.07 percent, its biggest single-day rise since January 7, 2009, when the yield had risen 71 bps, following an unexpected increase in the government borrowing programme. Trading in government bonds was extended by 30 minutes to 5:30 p.m.
The 1-year forward premium rate also surged 47.5 bps to 426.50 points, which is its highest level in nearly 15 years.
Late on Monday, the Reserve Bank of India raised short-term borrowing costs, restricted funds that banks could access and said it would drain cash from the market via a 120 billion rupees bond sale.
The steps make it harder to speculate in the rupee and are intended to attract foreign inflows needed to fund a record current account deficit.
Still, some economists said the RBI measures could prove successful and could lead to a pull back in bond yields.
"These are brilliant measures taken by the RBI. These steps will not have an immediate impact but gradually excess rupee liquidity will get squeezed out and it will help contain the dollar/rupee volatility," said Rupa Rege Nitsure, chief economist at Bank of Baroda.
The OIS rate curve saw a sharp bear flattening with the 1-year rate surging 116 bps to close at 8.76 percent, in its biggest one-day rise since at least 2000, while the 5-year rate jumped 50 bps to 8.09 percent.
(Editing by Jijo Jacob)
