The rupee rose 2.1 per cent on Friday, its biggest jump in nearly a year, as equities posted strong gains for a second session and the RBI was suspected to have sold dollars heavily late in the session.
However, the partially convertible rupee registered its second weekly loss, as investors fretted over fears of how the country will fund its large current account deficit as the US Federal Reserve is expected to begin tapering its monetary stimulus.
The rupee hit a series of record lows in the week, falling as much as 65.56 to a dollar on Thursday, making its Asia's worst performer so far in 2013.
Policymakers stepped in late Thursday to calm markets.
Finance Minister Palaniappan Chidambaram said that the rupee was "undervalued" and the current account deficit could be smaller than the previously estimated $70 billion.
Reserve Bank of India governor Duvvuri Subbarao also chimed in, saying that the central bank would continue with its cash tightening steps until the rupee stabilises.
"We are looking for a pullback in the USD/INR to 63.50-63.60 in the next two days (sessions) due to genuine exhaustion and positive US equities," said Dhirem Sarin, chief technical strategist, Asia-Pacific, at Barclays in Singapore.
Strong local stocks, which rose 1.1 per cent on Friday, and dollar selling by corporates helped the rupee.
The rupee has been trading in the oversold zone with its 14-day relative strength index hitting 82.8 due to six straight day of losses as of Thursday's close, implying increasing likelihood of the currency recovering some of its recent losses in short term, technical analysts say. Anything above 70 is considered oversold territory.
The rupee strengthened to 63.20/21 to a dollar as against 64.55/56 Thursday close, its biggest single day gain since Sept, 2012.
However, many foreign banks and brokerages continue to remain bearish on the rupee. Dealers said heavy central bank intervention in late trades pushed the rupee up.
Macquarie in a note said that weak investor sentiment meant that the rupee may weaken to 67-70 to the dollar in three months.
Indian equities, which have been relatively resilient to outflows, have seen $700 million of money going out in the five sessions to Thursday.
Foreign funds were net sellers of nearly $200 million in Indian equities on Thursday, a day when the benchmark index gained 2.3 per cent.
The 1-month offshore non-deliverable forward contract was quoted at 63.83 compared to the onshore one-month forward of 63.73.
In the currency futures market INRFUTURES, the most-traded near-month dollar/rupee contracts on the National Stock Exchange, the MCX-SX and the United Stock Exchange all closed at around 63.94 with a total traded volume of $3.4 billion.
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