The government's announcement to boost exports and attract more foreign capital on Wednesday lifted the rupee from near record lows and close with a gain of 7 paise at 60.40 against the US dollar.
A late recovery in local stocks and fag-end dollar selling by exporters also supported the currency.
The rupee opened sharply lower at 60.91 a dollar from the previous close of 60.47 at the interbank foreign exchange market and dropped to 61.20, near the all-time low of 61.21 recorded on July 8, on initial weakness in domestic equities and sustained dollar demand from importers.
Later, expectations of intervention by the Reserve Bank of India (RBI) at the lowest level and fresh dollar selling by exporters helped the rupee to bounce back to a high of 60.35 before settling at 60.40, a rise of seven paise.
Finance minister P Chidambaram on Wednesday said steps would be taken to further liberalise FDI and encourage public sector undertakings to raise funds overseas. He said the government is looking at raising import duty on non-essential luxury items and promoting exports. A sovereign bond issue to raise forex is an "an option on the table," he added.
The commerce ministry today also decided to raise the rate of interest on the subsidy scheme for exporters to 3% and widen the coverage of the scheme to cover more sectors.
"Rupee was seen recovering against the US dollar and erased the heavy losses incurred on Tuesday. It was seen gaining on the back of the positive statements given by the FM and some encouraging announcements made by the commerce minister," said Abhishek Goenka, founder and CEO of India Forex Advisors.
The benchmark S&P BSE Sensex on Wednesday ended flat, recovering from a 220-point fall. FIIs bought shares worth Rs 256.45 crore Tuesday, as per provisional data with the bourses.
In the global market, the US dollar was trading flat against its major rivals as investors awaited a statement on monetary policy from the US Federal Reserve and the preliminary estimate of second-quarter growth for the world's largest economy.
"The trading range for the spot USD/INR pair is expected to be within 60.20 to 61.00," said Pramit Brahmbhatt, CEO of Alpari Financial Services (India).
Forward dollar premiums fell back slightly on fresh receipts by exporters.
The benchmark six-month forward dollar premium payable in December softened to 223-227 paise from Tuesday's close of 223-1/2-228-1/2 paise. Far-forward contracts maturing in June declined to 446-450 paise from 448-452 paise.
The RBI fixed the reference rate for the dollar at 61.1150 and for the euro at 80.9535.
The rupee bounced back to 91.84 against the pound sterling from the previous close of 92.57 and to 80.11 per euro from 80.28. It eased further against the Japanese yen to 61.81 per 100 yen from 61.79.
The volatility in the currency led bond yields to jump, with the benchmark 10-year yield up 8 basis points at 8.33%.
RBI governor Duvvuri Subbarao is due to take questions from analysts on Wednesday afternoon; finance minister P Chidambaram too will address media later in the day.