The rupee rose slightly on Wednesday as a Reserve Bank of India (RBI) report recommending bringing down consumer inflation to a target of 4 per cent is seen benefitting the currency, despite raising concerns about economic growth in the near term.
The RBI report recommended making consumer inflation a priority for monetary policy, with a target of 4 per cent although within a plus or minus 2 per cent band.
That would likely mean elevated interest rates given consumer price inflation stands at 9.87 per cent, thus making the rupee higher yielding. Bringing down inflation would also remove a key constraint in the value of the rupee.
Rupee gains, closes at 61.81 vs US dollar
But higher rates in the near term could undermine confidence about an economy growing below the decade low of 5 per cent seen in the previous fiscal year ended in March 2013, while other uncertainties such as general elections due by May remain.
"We'd say that the impact of a new policy framework could be mixed for INR in the near term," said Sacha Tihanyi, a senior currency strategist at Scotiabank.
"In the interim, the biggest risks to INR remain a negative confidence shock, perhaps relating to the elections this year, though less related to US tapering, particularly if rates in India continue to rise."
The BSE Sensex rose 0.4 per cent to a record closing high on Wednesday, gaining for a third consecutive session.
The partially convertible rupee closed at 61.8150/8250 per dollar compared with its Tuesday close of 61.88/89.
The cost of holding one-year forward dollars rose to 482.75 basis points from 472.75 bps on Tuesday.
Dealers said the rupee was also supported by some dollar selling by state-run banks, and after the Sensex rose 0.4 per cent to a record closing high as drug makers rallied.
Investors will now await the central bank's monetary policy review as well the Federal Open Market Committee meet next week for directional cues.
In the offshore non-deliverable forwards, the one-month contract was at 62.21 while the three-month was at 63.02.