(Sept 15): Indian bonds declined after the central bank said it would sell sovereign notes to drain cash from lenders, adding to the supply of debt in a year when the market is already under pressure from record government borrowing.

Yields on the 6.94% bond due 2036 rose by 7 basis points to 7.09% while those on the 6.36% note due 2031 climbed 16 basis points to 6.78% as domestic bonds joined a global selloff. The rupee also weakened, with the central bank stepping in to support the currency as higher oil prices strained the country’s public finances. Indian markets were closed on Monday for a public holiday.

The Reserve Bank of India late Friday said it would drain one trillion rupees (RM42.5 billion) from lenders through bond sales, its strongest effort yet to soak up surplus cash in the banking system that poses inflationary risks. The additional supply is worsening the bond-market outlook just as high oil prices stoke inflation risks and raise the chances of an RBI interest-rate hike next month. Federal borrowing of close to eight trillion rupees is lined up over the next six months, when bond sales by provinces are typically heavy.

“The decision is the most stringent action the RBI has taken so far and the logical casualty has been the five-year segment, which was richly valued,” said VRC Reddy, head of treasury at Karur Vysya Bank Ltd. “I expect the yield curve to flatten further as short-end yields climb.” The gap between the five- and 10-year yield may stabilise around 20-30 basis points, he said.

India’s inflation climbed in August, moving closer to the top of the central bank’s 2%-6% target range. With price pressures rising, Citigroup Inc said it expects the RBI to raise borrowing costs by 50-75 basis points, with the tightening cycle starting next month.

The RBI’s bond sales will be carried out in three tranches, with the first one due on Sept 17. In that auction, the central bank will sell notes maturing in about three to six years.

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