The RBI's strategy to staunch the rupee's slide faced further setbacks on Friday, with investors betting a 150 billion rupee bond auction would struggle and the currency trading where it was before this week's rescue mission was launched.
An extended stand-off between the Reserve Bank of India and investors would raise the prospect of it taking other steps to generate demand for the rupee, such as increasing the level of reserves banks must hold, issuing offshore bonds or even raising policy interest rates.
Bond markets have been in turmoil since the RBI's extraordinary move on Monday to support the rupee by draining cash from the market and pushing up short-term interest rates, and a special bond auction on Thursday fell well short of its target.
Prime Minister Manmohan Singh said the steps were temporary and did not signal a rise in long-term interest rates. However, some economists say the central bank's efforts increase the risk it could have to raise rates even as the economy weakens.
The rupee has given up most of its gains since the RBI's move. On Friday it slipped to 59.83/84, close to its close of 59.89/90 on Monday. It hit a record low of 61.21 on July 8.
The benchmark 10-year bond yield was trading around 8 per cent, nearly 50 basis points higher than before the RBI's action.
"Once the short-term pressures have been contained, as I expect they will be, the Reserve Bank can even consider reversing these measures," Singh said on Friday, even as he conceded the government's forecast of 6.5 per cent economic growth in the fiscal year to March 2014 was unlikely to be met.
Private economists have been cutting their forecasts for growth, with Macquarie this week cutting its to 5.3 per cent. Economists and investors say India needs structural reforms in order to draw longer term foreign funds.
India's struggle to attract big-ticket investment was underscored this week when ArcelorMittal and POSCO separately scrapped plans for multibillion dollar steel mills due to difficulties acquiring land and other hurdles.
Asia's third-largest economy grew at 5 per cent in the fiscal year that ended in March, its weakest in 10 years.
On Thursday, the RBI rejected most bids in a sale of bonds designed to suck funds from the market, selling just over one-fifth of a planned $2 billion of debt as investors demanded higher yields than it would accept.
Signals were for another such stand-off at Friday's auction of