The rupee posted its biggest daily gain in three years on Friday after the government confirmed it will not impose retroactive taxes on foreign investors and as global risk asset rallied.
Euro zone leaders agreed on Friday to take emergency action to bring down Italy's and Spain's spiralling borrowing costs and to create a single supervisory body for euro zone banks by the end of this year, a first step towards a European banking union.
The improved global risk environment comes as investors are growing more hopeful of meaningful policy reforms at home after Prime Minister Manmohan Singh, a former central bank governor, took charge of the finance ministry.
The government released draft rules on Thursday and said the general anti avoidance rules, or GAAR, would not apply retroactively, a big concern for portfolio investors.
"The INR may outperform as well as India seems to be backtracking on its plans to retroactively apply new tax rules that would penalize a major foreign direct investor," said Dariusz Kowalczyk, senior economist & strategist for Asia ex-Japan at Credit Agricole.
The rupee settled at 55.6050/6150 as per State Bank of India data, rising 3.1 percent over its previous close. It rose 2.7 percent on the week, its biggest weekly gain in over two and half years.
That marked a turnaround after the rupee tumbled to a record low of 57.32 against the dollar a week ago.
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"I will wait for more clarity on the euro measures. The dollar/rupee broke a very important support at 56. If it sustains below that, we can see a further fall," said Abhishek Goenka, chief executive at India Forex Advisors.
India has been buffeted by various macroeconomic concerns, primarily the twin fiscal and current account deficits, leaving it vulnerable to capital outflows at a time of global risk aversion.
However, with Singh, widely credit with ushering in economic reforms in India in the 1990s, taking charge of the finance portfolio, investors are hoping he will push some much awaited reforms and address concerns on tax issues.
Global risk aversion has also improved. The euro surged following relief after the statement from European leaders, raising hopes it could help ease a big recent overhang in global markets.
One-month offshore non-deliverable forward contracts were quoted at 56.02.
In the currency futures market, the most traded near-month dollar-rupee contracts on the National Stock Exchange, the United Stock Exchange and the MCX-SX all ended at 56.0550. The total volume was at $4.9 billion.