The interest rates, or yields, on government securities on Tuesday dropped to two-and-half-year lows on expectations of more rate cuts from the Reserve Bank of India (RBI) amid a higher demand from foreign portfolio investors (FPIs).

Yields on the benchmark 10-year-bond dipped to an intra-day low of 6.31 per cent, a level last seen in December 2016, and ended at 6.33 per cent, which is almost 10 basis points lower than the previous close.

So far in this calendar year, foreign investors have pumped more than Rs 19,000 crore (over $ 2.50 billion) into debt, of which more than Rs 10,000 crore has come in this month itself.

Bond prices, which are inversely related to yields, have rallied strongly following finance minister Nirmala Sitharaman’s budget announcement of a sovereign bond issue by the government to meet its expenditure.

Government floating bonds in foreign currencies is expected to ease the pressure on the local markets; a fiscal deficit target of 3.3 per cent of GDP for the current fiscal has also improved sentiment.

Besides, expectations of more rate cuts by the Reserve Bank of India (RBI) have grown. Wholesale price-based inflation fell for the second consecutive month to a 23-month low of 2.02 per cent in June, helped by a decline in the prices of vegetables as well as fuel and power items.

Retail inflation remained below its medium-term target of 4 per cent, though it rose to a six-month high of 3.18 per cent in June, on costlier food items.

The forecast, earlier, was of the central bank at best going for one more rate cut of 25 basis points this year. But optimists feel it could bring down rates by 50-75 basis points, with inflation unlikely to cross four per cent and growth remaining muted.

Deutsche Bank said in a recent note that the yield on the benchmark government bond may even drop to 6-per-cent levels by the end of this calendar year.

Meanwhile, an internal working group of the RBI is set to submit a report on a framework to manage the liquidity in the economy. In its statement on developmental and regulatory policies last month, the central bank had announced the formation of such a panel. The group has been told to review the existing liquidity management framework and suggest measures to simplify the framework.

Rupee falls

The rupee on Tuesday depreciated 17 paise to close at 68.71 against the dollar because of rising crude oil prices and foreign fund outflows. The Sensex on Tuesday rose 234 points to 39031.04 points, while the Nifty was up 72 points at 11661.05

A strengthening dollar against major currencies overseas also weighed on the rupee sentiment, forex traders said. However, sustained buying in the domestic equity market restricted the rupee’s fall, they added.

At the interbank foreign exchange (forex) market, the domestic currency opened lower at 68.59 to the dollar and further lost ground to touch the day's low of 69.76. The rupee finally settled at 68.71, down 17 paise over its previous close. The rupee had settled at 68.54 against the dollar on Monday.