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The rupee rose to its highest level in three weeks on Tuesday as a broad selloff in global commodities raised hopes the pressure on the country's record current account deficit will ease and give the central bank more room to cut rates.
The rupee rose 0.9% on the day, in its biggest single-day gain since January 30 when it had risen by a similar percentage.
Traders said the positive downside surprise on the March inflation front has also helped cement rate cuts bets at the RBI's upcoming annual monetary policy on May 3.
India's headline inflation slowed to its lowest rate in three years in March, data on Monday showed, closely following the retail inflation data released last week which edged down towards single-digits.
"Unwinding of long dollar positions on the back of the commodities rally is boosting the rupee. Yesterday's inflation data has also reinforced rate cut bets," said Ashtosh Raina, head of foreign exchange trading at HDFC Bank.
"There is no target for the USD/INR as such, as it depends on the existing long dollar positions in the market but the rupee should continue to gain for some more time," he added.
The partially convertible rupee closed at 54.15/16 per dollar versus its previous close of 54.6250/6350. The rupee rose to as high as 54.12, its strongest since March 25.
Sharp gains were also seen in the domestic share market with the benchmark BSE Sensex gaining 2.1% as rate-sensitive stocks like banks and autos rose on hopes the central bank will cut rates next month on a continued slump in global commodity prices.
In the offshore non-deliverable forwards, the one-month contract closed at 54.40 while the three-month was at 54.99.
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 all closed at around 54.25 with a total traded volume of around $6.80 billion.
