MUMBAI (Reuters) - India plans to launch trading of government bond futures within the next two months as part of efforts to deepen its financial markets, according to several sources involved in the discussions with the central bank.

These interest rate futures would help banks and financial firms in Asia's third-largest economy assess expectations for borrowing costs and hedge the risks of rate changes to their bond portfolios.

Policymakers would also have a valuable gauge to measure market expectations for future rate decisions.

Although the plans are at an advanced stage, the sources said the Reserve Bank of India (RBI) has not yet finalised the structure of the interest rate futures product, which will allow investors to bet on the direction of rates. They declined to be identified publicly commenting on the closely-held discussions.

"This product is Rajan's baby so everyone is on their toes to make it a success. It will be launched in a month or two months at the most," said one senior market participant who has been in discussions with the RBI, referring to new RBI Governor Raghuram Rajan.

The RBI has long been keen to develop a proper market gauge of future interest rates but failed in two previous attempts in 2003 and 2009 because of what market participants have said were faulty designs.

The sources said the RBI for now is leaning towards benchmarking interest rate futures contracts against a basket of bonds with varying maturities as opposed to using only the benchmark 10-year bond as the basis of pricing the contract.

Furthermore, the RBI is considering making settlements cash-based as opposed to requiring financial firms deliver the actual security to the investor, in what is called a physical delivery.

(Reporting by Archana Narayanan and Suvashree Dey Choudhury; Editing by Kim Coghill)