The rupee strengthened on Monday, encouraged by the government's move to ease restrictions on foreign investments in debt markets and the global risk-on sentiment, but gains were pared on worries over political uncertainty.
The currency benefited from expectations of additional foreign inflows after the government eased restrictions for foreign investors in domestic debt.
Global risk sentiment also improved after the euro gained as Cyprus clinched a last-minute bailout deal with its lenders.
However, broader sentiment for the Indian currency remains weak following media reports that another key ally of the ruling coalition government in New Delhi could withdraw its support.
"The sentiment for the rupee is negative at the moment, considering the political uncertainty coupled with euro problems," said Ashtosh Raina, head of foreign exchange trading at HDFC Bank.
The partially convertible rupee closed at 54.175/185 per dollar versus 54.33/34 on Friday, after touching 54.06, its highest level since March 19.
The rupee could hit a low of 55.00-55.25 against the dollar if the political scenario worsened, said Naveen Mathur, associate director for currencies and commodities at Angel Broking.
Local media reported the Samajwadi Party may consider withdrawing support from the government. Party leader Akhilesh Yadav was not immediately reachable by Reuters.
The reports have raised concerns about the stability of the government even as it continues to introduce new fiscal and economic reforms such as the eased restrictions for foreign investors in debt announced over the weekend.
In the offshore non-deliverable forwards, the one-month contract was at 54.58 while the three-month was at 55.17.
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 54.58 with a total traded volume of $4.2 billion.