The benchmark 10-year bond yield closed at 6.08%, down 5 basis points on the day after earlier rising to 6.18%, its highest since April 7.
Benchmark yields rose 12 bps in a surprising development on Thursday even as the RBI bought 250 billion rupees ($3.36 billion) worth of bonds in the first tranche of its 1-trillion-rupee government securities acquisition programme (G-SAP) for the quarter.
On Friday, RBI sold bonds worth 113.27 billion rupees, less than half of what it set out to raise for the government and rejected all bids at the sale of the 10-year bond.
"The RBI managed to trigger a short-covering rally by rejecting the 10-year bids. But what happens next?" a senior trader at a private bank asked, saying that the RBI would need to give up on its desire of trying to artificially hold yields around a certain level and let the market find an appropriate level.
The central bank has repeatedly assured bond markets of ample liquidity to help the smooth sailing of the government's market borrowing programme worth 12.06 trillion rupees for the new fiscal year, but rising inflation and non-stop debt supply has meant the market has been reluctant to let yields stay lower.
India's March wholesale price-based inflation rose 7.39%, sharply above the analysts' forecast for a 5.9% increase while retail prices accelerated to a four-month high.
The RBI's decision to pump in cash through the G-SAP programme has also complicated its task of currency management with the rupee falling against the dollar in recent sessions on expectations of a glut in domestic rupee liquidity.
It touched a nine-month low of 75.32 on Thursday. However, on Friday, the partially convertible rupee rallied on the back of exporter dollar sales and gains in domestic stocks to close at 74.35 per dollar versus the previous close of 74.92.
It rose 0.8% on day, its best daily performance since March 3, with dollars sales by state-run banks likely on behalf of the RBI also aiding.
The unit also snapped two weeks of losses to post its best week against the dollar in six, rising 0.5% on-week, the highest since the week ended March 6.
($1 = 74.4540 Indian rupees)
(Reporting by Swati Bhat, Editing by Sherry Jacob-Phillips)
By Swati Bhat