UPDATE 1-India cbank meets bankers on bond yields-sources

* Yields have leapt over 200 basis points so far this year

* State-run banks meet cbank to discuss market conditions

* Rising yields increase govt's borrowing costs - HDFC (Adds details, cbank, analyst comments)

By Saikat Chatterjee and Neha D'silva

MUMBAI, March 13 (Reuters) - India's central bank has met with officials from state-run banks to discuss a jump in bond yields, which analysts say is undermining monetary policy and threatening to ramp up the cost of government borrowing, sources said on Friday.

Two industry sources said senior bank officials met in individual meetings with the central bank to talk about bond yields in the run up to the end of the fiscal year on March 31.

One state bank official who attended a meeting with deputy governor Shyamala Gopinath and some of her team said the talks were mainly about the state of the government bond market and the amount of bank deposits invested in bonds.

"The meeting was to take stock of what is happening in the bond markets and listening to our feedback, rather than them asking us what suggestions we can give them," another bank official who was briefed on the outcome of a meeting said.

A central bank spokeswoman did not comment on the matter.

Banks have to invest 24 percent of their deposits in federal bonds but their holdings in early January stood at 28.9 percent, central bank data showed, which could indicate bank appetite to buy more bonds will be limited.

At Friday's high of 7.37 percent, the yield on the most-traded 8.24 percent 2018 federal bond IN082418G=CC has jumped 62 basis points this week, and more than 100 basis points this month.

It is up more than 200 basis points so far this year, even as the central bank has cut its key policy rates by 100 basis points in two moves.

Among the state-run banks who met the central bank on Thursday were Punjab National Bank (PNBK.BO), Union Bank of India (UNBK.BO), and Bank of Baroda (BOB.BO), the sources said.

A total of five banks including State Bank of India (SBI.BO), the country's biggest lender, have met the central bank since last week. An association of primary dealers met two weeks ago.

SUPPLY FEARS

Analysts say the meetings reflect the central bank's difficulty in trying to manage a big slab of government borrowing planned at the tail end of the fiscal year when state-run banks are closing their books.

Government borrowing for 2008/09 has already doubled to 3.06 trillion rupees ($59.3 billion), with 910 billion of that announced since Feb. 10, and is set to rise to a record 3.6 trillion next year.

Including borrowings by state governments, the market faces supplies of 4.5 trillion rupees in 2009/10, against investor demand for 3.05 trillion rupees, ICICI Securities said.

Bankers say the sharp surge in yields will erode a large chunk of banks' treasury profits at a time they are struggling with rising bad loans and a slowing economy.

Abheek Barua, chief economist at HDFC Bank, said higher yields would increase the borrowing costs of the government, making it more difficult to bring down the overall fiscal deficit that is expected to rise to around 10 percent in 2008/09.

"It is a possibly exploding spiral which has to be avoided and I think it is a enormous concern," Barua said.

Some of the suggestions put forward by market participants are for the central bank to buy back more widely held debt rather than illiquid paper and relaxing accounting norms for bond investments.

Currently, only bonds that are held till maturity -- or a quarter of the total -- are exempted from marked-to-market pricing in the books. ($1 = 51.6 rupees) (Editing by Ranjit Gangadharan)