The rupee closed higher on Thursday as foreign funds continued to invest in local debt, though weak domestic shares and dollar demand from oil importers put a lid on gains.
The Reserve Bank of India (RBI) probably sold dollars around the Rs 51.74 level in late trading, which further supported the currency, traders said.
The rupee ended at 51.60/61 to the dollar, up from Wednesday's close of 51.90/91, rising as high as 51.52 after the suspected intervention.
"The rupee's recent gains have been flow-driven, but the outlook is weak because the debt crisis in Europe is far from over," said S. Nagaraja, head of forex dealing at Al Rostamani International Exchange.
"However, sharp volatility is unlikely because the Reserve Bank of India will put a check on sharp moves in either direction," he added.
In an attempt to arrest the sharp slide of the rupee, the RBI intervened in the forex market for a third consecutive month in November in its biggest sale of dollars in more two-and-half years, data released on Thursday showed.
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Net inflows into Indian debt so far in January stand at about $2.07 billion, substantially more than the $387.15 million invested in equities, data from the Securities and Exchange Board of India showed.
Traders and economists expected the rupee to weaken in the weeks ahead on worries about India's current account deficit, and as investors remain wary of taking on risky assets.
The currency of a country that runs a sustained trade deficit has to depreciate, V. Balakrishnan, chief financial of Infosys Ltd, said after India's No. 2 software exporter released quarterly results.
"India is seen as an emerging market risk," he said. "To that extent money is not coming in when the environment is very volatile," he said, adding India's political system is paralysed and no reforms are happening. "So if you put all this together, the currency has to depreciate," Balakrishnan said.
The BSE Sensex closed down 0.9% after Infosys cut its full-year revenue forecast.
Strong factory data for November failed to allay concerns about economic growth.
Industrial production recovered in November, rising 5.9% from a year earlier. Traders are now awaiting December headline inflation data due on Monday for clues on what action, if any, the RBI will announce on January 24.
The euro edged up, helped by strong demand at an auction of Spanish bonds but it faces selling if the European Central Bank, which is meeting on Thursday, hints at more interest rate cuts.
One-month offshore non-deliverable forward contracts were quoted at 52.04, indicating some weakness in the short-term in the onshore spot rate.
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 51.8 on total volume of $4.3 billion.