The rupee rose to its highest level in two weeks on Tuesday, strengthening for a second straight month, after a cut in tax on interest payment to foreigners on debt raised hopes of more dollar inflows.
The government will cut the withholding tax on interest payments to foreigners on government and corporate debt to 5 percent from up to 20 percent for a two-year period, in a bid to draw further inflows to bridge its current account deficit and polish its reformist credentials.
"The withholding tax cut is being seen as a positive by markets. I think we can see 53.50 levels this week," said Uday Bhatt, a dealer with UCO Bank.
"A 25 basis point cut in rates on Friday is discounted by the market, so the tone will be key in providing further direction," he added.
Traders are hopeful of more foreign fund inflows into the debt market following the tax cut as despite having increased the limits on foreign fund investments in domestic government and corporate debt, the limit utilisation has been low.
The partially convertible rupee closed at 53.80/81 per dollar compared with its close of 54.23/24 on Monday. The unit rose to as high as 53.79, its strongest since April 17. On the month, the rupee gained 0.9 percent taking its total gains in 2013 to 2.2 percent.
Gains in regional shares and currencies also boosted the rupee. Asian shares advanced with investor risk appetite bolstered by expectations for U.S. Federal Reserve and the European Central Bank to continue with growth-supportive monetary stimulus measures.
Indian shares closed at their highest in 1-1/2 months led by gains in Hindustan Unilever after its parent made a $5.4 billion offer to raise stake in it, while the finance minister's comments that tax residency certificate is enough proof of residency for tax purposes also helped.
The Unilever offer, which will begin in June, is also likely to help the rupee, traders said.
In the offshore non-deliverable forwards, the one-month contract was at 53.90 while the three-month was at 54.46.
In the currency futures market, 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 53.94 with a total volume of $6.1 billion.