Earlier in the day, states raised 160 billion rupees ($1.92 billion), the lowest for a weekly auction, via 10-year bonds at around 7.74%.
The 10-year benchmark bond yield was around 7.21%, marking a spread of 53 basis points, compared to around 48 bps last week.
The spread was the widest in over two years, and traders anticipate further widening in the coming weeks.
"Premium collection with insurers has improved, and the supply could be absorbed by them, but spread widening with government bond yields is not ruled out and should happen," said Alok Singh, group treasury head at CSB Bank.
States are scheduled to borrow a record 4.13 trillion rupees ($49.57 billion) in the quarter, over two-thirds of the previous three quarters combined, a release on Friday showed.
Having raised 6.04 trillion rupees from April-December, if the January-March borrowing schedule is fully utilised, states' annual borrowing would cross 10 trillion rupees for the first time ever.
"State bond yields have remained artificially lower for a long time, but with supply rising, we expect them to rise to 50-60 basis points, and at these levels we would be on the buy side," said Aneesh Srivastava, executive director and chief investment officer at Star Health Insurance.
Traders also said that demand for ultra-long central government bond yields will be impacted, as this segment is generally bought by long-term real money investors.
The 30-year and 40-year yields were around 7.45%, and traders anticipate their spread with the benchmark yield to widen to around 30 bps by the end of March, from 25 bps currently.
($1 = 83.3201 Indian rupees)
(Reporting by Dharamraj Dhutia; Editing by Varun H K)
By Dharamraj Dhutia
