The rupee rose to a five-week high on Friday, propelled by dollar flows into local debt and equities as a rebound in factory production suggested an improving economic outlook.
Strong demand at Spanish and Italian debt auctions also encouraged investors to take on more risk, helping to boost the Indian currency, traders said.
At 11:02 a.m. (0532 GMT), the rupee was at 51.45/46 to the dollar after hitting 51.3550, a level last seen on December 7. It closed at 51.60/61 on Thursday.
"The rupee is being supported by the improvement in global risk sentiment," said Gaurav Garg, Asia foreign exchange and local markets strategist at Citigroup in Singapore.
"And steps taken by the Indian authorities like liberalisation of the single-brand retail and the deregulation of interest rates on non-resident deposits, inflows of which are generally sticky in nature, are seen boosting dollar inflows."
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.
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Citigroup's Garg, however, believes the rupee is unlikely to strengthen beyond 49 to the dollar during 2012 and that it will continue to underperform other major Asian currencies because of India's current account and budget deficits.
New Delhi is widely expected to miss by a large margin its fiscal deficit target of 4.6% of GDP for the financial year that ends in March.
Data released by the Reserve Bank of India on December 30 showed that while the current account deficit remained unchanged at $16.9 billion in the September quarter from a year earlier, the trade gap widened to $43.9 billion.
Industrial output rose 5.9% in November in a sign that the economy was gathering momentum and that the RBI may not ease rates immediately.
One-month offshore non-deliverable forward contracts were quoted at 51.82, 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 51.65 on total volume of $1.09 billion.