The Indian rupee posted its biggest single-day gain in over two months on Tuesday, snapping a three-day falling streak after the central bank unexpectedly raised interest rates to bring down consumer inflation.
Investors were also comforted after the Reserve Bank of India (RBI) indicated it did not foresee more near-term policy tightening should retail inflation ease in line with the central bank's projections.
The rupee has had an uneasy relationship with the prospect of interest rate hikes. Although higher rates can make the currency more attractive for foreign investors, too much tightening can dent economic growth, eroding confidence, and in turn hitting stocks.
The rate hike was intended to curb inflation but also comes as emerging markets have been routed in part by expectations the Federal Reserve will continue to wind down its monetary stimulus after concluding its two-day meeting on Wednesday.
"We are now looking ahead at the Federal Reserve policy outcome but I don't think the rupee will weaken more from here. 63 should hold at the top for the pair," said Uday Bhatt, a foreign exchange dealer with UCO Bank.
The partially convertible rupee closed at 62.51/52 per dollar compared with 63.10/11 on Monday. The 0.9 percent rise in the rupee is the biggest since Nov. 18.
The RBI's hike in interest rates also pushed up the marginal cost of borrowing rupees in the overnight market, making it more expensive to fund investments in dollars and thus prompting liquidations of long positions in the greenback.
Traders will continue to monitor foreign fund inflows and outflows from both the debt and equity markets for direction.
Corporate dollar selling by a large engineering firm also helped the rupee, dealers said.
In the offshore non-deliverable forwards, the one-month contract was at 63.14, while the three-month was at 64.00.