The rupee rose to a near two-week high on Monday as manufacturing activity returned to growth in November, but trimmed gains after the central bank said state-run oil companies were sourcing all of their dollar needs in markets.
The return of oil marketing companies to sourcing dollars in foreign exchange markets marks the end of a special window, implemented late-August, to provide the greenback to these refiners.
Many analysts have said the move supported the rupee.
The Reserve Bank of India has also closed two separate concessional windows that helped banks raise funds overseas, and which attracted a total of $34 billion since September.
Although the withdrawal of the support to the rupee comes amid signs of an improving domestic economy and a more stable currency, traders nonetheless remained cautious, given the underlying issue of when the US Federal Reserve would start tapering its bond buying.
"Generally, people were not expecting the full oil buying so it reacted a bit negatively.
"They were thinking 80 per cent is through the market, while 20 per cent through RBI," said Anil Kumar Bhansali, vice-president
The partially convertible rupee closed at 62.315/325 per dollar compared with 62.44/45 on Friday.
It rose to 61.965 during the session, its best level since November 19.
The session high came after a report showed the HSBC Manufacturing PMI, compiled by Markit, rose to 51.3 in November from October's 49.6, returning above the 50 mark which separates expansion from contraction, after three months.
The positive PMI reading comes after data on Friday showed Asia's third-largest economy grew at a higher-than-expected rate in the three months through September.
However, the rupee trimmed gains later, while the dollar/rupee forward premium also rose on the central bank advising banks to spread out their dollar demand by buying greenbacks in forward markets ahead of periods of pent-up demand.
The one-month premium rose to end at 46.25 bps from its previous close of 45.50 bps, while the one-year premium was at 489 bps versus 494 bps previous close.
In the offshore non-deliverable forwards, the one-month contract was at 62.70, while the three-month was at 63.65.