The rupee rose the most in over two months on Thursday after the government agreed to a vote in parliament on allowing foreign investment in multi-brand retail, raising hopes it would muster a majority and push through key reforms.
The rupee, which has been buffeted by concerns of fiscal deficit and a gaping current account gap, found renewed vigour as the government showed spunk and allowed a non-binding vote in parliament on foreign investment in multi-brand retail.
The move raised hopes the opposition would now let parliament function smoothly, allowing the passage of key legislation such as foreign investment in pension and insurance, banking law amendment and other bills.
"The feeling is that the UPA (United Progressive Alliance) will do something to get support and that reforms will become a reality," said Subramanian Sharma, director at Greenback Forex, a forex advisory firm.
"The break of 55.20 saw the unwinding of long dollar positions and I expect the rupee to move towards 54.20-53.80 to the dollar in the first quarter of next year," he said.
The government move sparked a rally in local equity markets, with the benchmark indices hitting their highest close in 19 months.
Goldman Sachs upgraded Indian equities to 'overweight' from 'market-weight', citing growth recovery and inflation moderation ahead. The Wall Street investment bank also said it was hopeful about the economy in 2013 and 2014.
A further boost was provided by the substantial gains in global markets and commodities as comments from a senior U.S. lawmaker raised hopes of a budget deal by the year-end to avoid a fiscal crisis in the world's biggest economy.
Dealers said foreign institutional investors sold dollars to buy local equities, having already invested $1.2 billion in local stocks in November.
The partially convertible rupee closed at 54.8350/8450 per dollar, up 1.1 percent, its biggest daily gain since September 21.
The rupee hit an intraday high of 54.76, its highest in two weeks, and compared with its previous close of 55.45/46 on Tuesday.
The economy will again be in focus on Friday when the government will detail the July-September GDP data.
India's economy probably expanded near its slowest pace in three years in the quarter to September, according to a Reuters poll, suggesting there were few signs of an early turnaround, despite the reform steps taken by the government to lure back investors.
In the offshore non-deliverable forwards market, the one-month contract was at 55.13 while the three-month was at 55.70.
In the currency futures market, the most-traded near-term dollar/rupee contracts on the National Stock Exchange, the MCX-SX and the United Stock Exchange all closed at around 55.08 with a total traded volume at around $6.4 billion.