The Indian rupee recovered on Wednesday from early falls as worries over political instability eased and on the back of dollar sales by custodian banks and a state-run company.
Markets had been rattled by a double whammy on Tuesday, when a key ally withdrew support from the ruling coalition and the central bank said the room for future rate cuts was limited despite easing monetary policy by 25 basis points.
Some of the concerns about the standing of the ruling coalition eased after the Indian government said on Wednesday it was still able to pass reform legislation in parliament, but ministers did not answer questions on whether it would call a snap election.
The global risk environment will also be key after Cyprus rejected the terms of a proposed bailout, although domestic investors were comforted after the euro held firm against the dollar on Wednesday.
"Some inflows were heard of in the market, and it seems market yesterday over-reacted to questions over stability of government. Now it seems like some calm is returning," said Uday Bhatt, a foreign exchange dealer with UCO Bank.
The partially convertible rupee closed at 54.36/37 per dollar versus 54.37/38 on Tuesday. The rupee initially dropped as low as 54.56, its weakest since March 8.
Traders now expect the rupee to move in a 54.20 to 54.80 range during the week, with share movements likely to be a factor.
The benchmark BSE index fell on Wednesday for a fourth consecutive session, hitting a two-week closing low.
"We expect the RBI's cautious policy guidance and euro-area tail risks to put a short-term floor under USD/INR. The upside to USD/INR, however, is likely to be limited by continued capital inflows," Standard Chartered Bank said in a note.
In the offshore non-deliverable forwards, the one-month contract was at 54.78 while the three-month was at 55.41.
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 closed at around 54.44 with a total traded volume of $5.56 billion.