Nov. 7 (Bloomberg) -- India's 10-year bonds had their worst week in more than a month after the central bank said it may lower the limit on debt some banks need to hold to free up cash.

The yield on the benchmark note was near a one-week high after the Reserve Bank of India said it will offer currency swaps for local banks to meet any shortage of foreign exchange at their overseas units. The central bank also said it may allow some banks to reduce their statutory bond holdings and raise cash to buy the currency swaps.

``It is a pro-active measure for the currency market at the expense of the bond market,'' said Srinivasa Raghavan, head of treasury at IDBI Gilts Ltd. in Mumbai, a primary dealer that underwrites government debt sales. ``The measure will spur selling of securities as foreign exchange needs of banks are strong and funding sources are limited.''

The yield on the benchmark 8.24 percent note due April 2018 rose 19 basis points this week to 7.69 percent at the 5:30 p.m. close in Mumbai, according to the central bank's trading system. The price fell 1.33 rupees per 100-rupee face amount, to 103.6375. A basis point is 0.01 percentage point.

Local banking rules require lenders to keep 24 percent of their deposits in the form of low-risk securities approved by the regulator. The central bank on Nov. 1 reduced the so-called statutory liquidity ratio from 25 percent, spurring sales of securities.

Debt Auction

Bonds also fell this week on speculation investors sold to make room for 100 billion rupees ($2.1 billion) in debt offered at an auction today.

The government sold 60 billion rupees of the benchmark 2018 notes at a cut-off price of 103.39 rupees, or 7.7269 percent yield, and 40 billion rupees of the 8.28 percent notes due 2032 at 98.33 rupees, or 8.443 percent yield.

Primary dealers picked up 12.3 billion rupees of unsold 2032 debt.

Bonds pared the week's losses with a two-day advance on speculation rising cash at local banks, the biggest buyers of government debt, will increase demand for the securities.

Lenders have parked rupee funds with the central bank for three straight days after borrowing from the monetary authority in the previous five days, data from the daily repurchase auctions show. The Reserve Bank freed up as much as 1.4 trillion rupees by reducing the amount lenders need to set aside to cover deposits four times since Oct. 11.

The rate at which banks lend to each other overnight declined to 6.3 percent after reaching a 19-month high of 19.5 percent on Oct. 31.

``Liquidity needs of the banking system have been met before they had an adverse impact on the overall financial system,'' said Baljinder Singh, a trader at state-owned Andhra Bank in Mumbai. ``The underlying sentiment for bonds is improving, which will help yields decline further.''

The cost of five-year interest-rate swaps, or derivative contracts used to guard against rate fluctuations, fell. The rate, a fixed payment made to receive floating rates, dropped to 6.61 percent from 6.75 percent yesterday.

To contact the reporter on this story: Anoop Agrawal in Mumbai at aagrawal8@bloomberg.net.

Last Updated: November 7, 2008 07:46 EST