The rupee rose for the first time in three sessions on Tuesday, aided by an upswing in domestic stock prices and an increased appetite for risk, although it finished off the day's high as oil importers stepped up buying of dollars.
The rupee closed at 53.21/22 to the dollar, 0.2 percent up from Monday's close, after touching a high of 53.11.
Oil is India's biggest import item and oil refiners are the largest buyers of dollars in the local market.
The BSE Sensex closed 2.7 percent higher as investors bet that the RBI will soon start cutting interest rates, while resilience in the manufacturing sector and a surprise drop in German unemployment lifted global stocks and the euro.
We think it's a temporary phenomenon, driven by improvement in Indian and Chinese PMIs, said Dariusz Kowalczyk, senior economist at Credit Agricole in Hong Kong.
Risk aversion is likely to return because the euro zone crisis has not been solved.
Indian manufacturing activity surged to a six-month high in December, helped by a jump in new orders, a survey of purchasing managers showed.
However, economists say a large current account deficit, high oil prices and weakening external demand would continue to weigh on the rupee, the worst performer among Asian currencies in 2011.
Steps taken by the RBI to aid the rupee could limit its fall to 54.40, said Jonathan Cavenagh, senior currency strategist at Westpac Institutional Bank.
On Sunday, New Delhi said it would allow individual foreign investors to directly buy stocks from January 15. It was the latest step to liberalise Asia's third-largest economy after a year of big losses in the stock market.
The market will closely watch the ISM Manufacturing PMI data in the United States, due at 1500 GMT, for further signs of recovery in the world's biggest economy, traders said.
One-month offshore non-deliverable forward contracts were quoted at 53.58 rupees.
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 were all around 53.52, with the total volume at $2.8 billion.