Yields on the benchmark 10-year Government bonds climbed to a three-week high on Tuesday after the Government announced a surprise Rs 150bn auction late on Monday.
The benchmark 10-year government bond yield was last quoted at 8.48% after being as low as 8.54% earlier in the day.
The price of the 8.79% note expiring in 2021 was at Rs. 102.05, up 9 paise on the day.
The 10-year yield closed at 8.49% on Monday before the auction announcement.
The Government will sell Rs. 150bn of bonds on December 30 in an unscheduled auction to partially offset a Rs. 40bn auction cancelled last month and to fund an emerging cash requirement, the finance ministry said on Monday.
The move unsettled markets amid growing concerns about the bloated fiscal deficit.
The Government is widely expected to miss its target of paring budget shortfall to 4.6% of GDP in FY12 due to deceleration in tax collection and higher spending.
In late September, the Government increased its market borrowing estimate for the October-March period to Rs. 2.2 trillion, from Rs. 1.67 trillion.
Liquidity in the banking system remained tight on Monday with banks borrowing ~Rs. 1.43 trillion from the RBI's repo window, significantly more than the central bank's comfort level of around Rs. 600bn.
Traders in the money market expect more open market operations from the RBI to ease the tight cash conditions.
Liquidity could improve in January as Government spending picks up pace before the end of the financial year in March.
Meanwhile, a top government official was quoted as saying that the Government will not increase its overall market borrowing for the second half of FY12.
The official was quoted as saying that the Government is still to decide whether to announce additional market borrowing in the second half of FY12.