Indian bonds gained on Tuesday after the central bank announced it would sell a new 10-year paper, lifting sentiment as traders expect strong demand for the new debt while a key source of uncertainty is now removed from markets.

The Reserve Bank of India, which manages the country's debt on behalf of the government, said it would sell a larger-than-expected Rs 9,000 crore ($1.42 billion) of a new 10-year bond on Friday.

The sale will come as part of a weekly auction of debt totalling Rs 16,000 crore.

Traders estimated the new bond could be sold around 7.72 per cent to 7.74 per cent, below the existing 10-year benchmark bond yield of 7.89 per cent.

The new bond was changing hands at 7.72 per cent in the "when-issued" segment, a market where bonds trade ahead of the actual sale and are settled after the auction concludes.

"The market should improve, as globally conditions are also improving, and I think the new 10-year yield cut-off should be 15 basis points below the existing 10-year benchmark," said A. Prasanna, economist at ICICI Securities Primary Dealership Ltd.

The current benchmark 10-year bond yield was down 1 basis point at 7.89 percent from its close, in a volatile session.

Traders puzzled

Traders had reacted with confusion on Tuesday when neither the central bank nor the finance ministry made an announcement on Monday about whether it would hold a debt auction this week.

India typically sells debt every week, announcing the composition of the auction on Monday evenings.

A finance ministry official said a decision to delay an announcement was made because of the goverment's comfort with its cash position, now at 983.52 billion rupees.

The eventual announcement on Tuesday was meant to remove some of the confusion in markets, according to the source.

Interest rate cuts?

The sale of a new 10-year bond comes ahead of the RBI's policy review on June 2, when the central bank is expected to cut interest rates for a third time this calendar year.

The RBI is also selling more of the 10-year bonds than the Rs 7,000 crore traders had expected, making the debt more liquid, while removing some of the uncertainty in markets.

Traders say a succesful sale could help a recently struggling bond market. The existing 10-year bond yield has risen nearly 10 bps since mid-April on worries about the impact of a retroactive tax on foreign investors and a sell-off in global debt markets.

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