The rupee on Tuesday bounced back 21 paise, its biggest gain in more than two weeks, to close at 61.31 against the dollar after the RBI hiked a key interest rate to curb price rise and enhanced liquidity for banks.
The rupee got a boost as stock market investors cheered the Reserve Bank's steps. Fresh dollar sales by exporters amid sustained capital inflows also supported the local currency.
The rupee opened lower at 61.60 a dollar from the previous close of 61.52 and dropped to a low of 61.72. Later, it rebounded to settle at the day's high of 61.31, a rise of 21 paise or 0.34 per cent.
It was the biggest gain for the rupee since climbing 32 paise to 61.07 on October 11.
The RBI increased the policy repo rate to 7.75 per cent and cut the marginal standing facility rate to 8.75 per cent, as was widely expected.
It increased liquidity provided through seven-day and 14-day term repos.
"RBI was seen acting as per the expectations as it hiked the repo rate by 25 bps and cut down the MSF by 25 bps.
"Later during the day, the rupee was seen posting gains supported by the rally in stock markets," said Abhishek Goenka, CEO of India Forex Advisors.
The 30-share S&P BSE Sensex rallied 359 points, or 1.74 per cent, to an almost three-year high of 20,929.01, snapping a five-day losing trend.
Overseas investors bought a net Rs 636.78 crore of shares yesterday, according to provisional data with the stock exchanges.
The dollar index was trading 0.18 per cent higher against a basket of six major currencies.
"The dollar index is trading strong ahead of data on US retail sales and consumer confidence, due later in the day, which capped the rupee gain," said Pramit Brahmbhatt, CEO of Alpari Financial Services (India).