INDIA BONDS-Indian bonds hang tight ahead of supply

By Khushi Malhotra

MUMBAI, Oct 16 (Reuters) - Indian government bonds were pinned in a narrow range on Friday, as a hefty auction of benchmark 10-year debt kept traders guarded while they assessed the central bank's policy outlook.

The benchmark 6.94% 2036 bond yield was at 7.3895% at noon, versus 7.3921% on Thursday. Bond yields move inversely to prices.

New Delhi's 340 billion rupee ($3.58 billion) sale of the 10-year paper will test demand in a market already swamped by supply, where concerns have intensified since central and state borrowing calendars tilted toward longer-dated issuance.

A sharp retreat in US Treasury yields, however, offered some support. The 10-year Treasury yield fell 11 basis points to 5.08% in the previous session.

Traders are also recalibrating for the Reserve Bank of India's rupee defence, which could involve tolerating higher domestic yields to preserve the spread over US rates.

The RBI is expected to tighten financial conditions further to stem capital outflows and raise the cost of shorting the rupee, though it is unlikely to reprise the aggressive measures deployed during an earlier currency crisis, sources and analysts told Reuters.

The central bank raised policy rates this month for the first time in nearly four years and has drained liquidity through bond sales, tighter reserve requirements and stricter forex-hedging rules.

"Bonds, to some degree, are paying the price for the authorities' efforts to defend the rupee against the additional headwind of weak global conditions," DBS Bank said.

Above-target inflation and the rupee's roughly 6% decline this year have stoked bets on a larger December rate hike, lifting short-end yields and swap rates.

Tighter daily cash reserve ratio rules, effective Friday, may add to pressure on short term bonds.

RATES

India's overnight indexed swap rates fell as easing rupee forwards brought relief.

The one-year OIS rate eased 3.5 bps to 6.5025%, while the two-year rate fell 4.25 bps to 6.5925%, and the five-year rate dropped 2.75 bps to 6.76%.

($1 = 95.0550 Indian rupees)