The rupee climbed to its highest level in 35 months on Wednesday, tracking the euro's gains against the dollar and stronger Asian peers.
A bigger-than-expected interest rate increase by the RBI on Tuesday is also underpinning the rupee, traders said.
At 11:35 am, the partially convertible rupee was at 43.89/90 per dollar, after hitting 43.8550, its highest since August 29, 2008 and 0.6% stronger than its close of 44.1750/1850 on Tuesday.
"The euro has strengthened. Also, because of the rate hike, people are expecting money to come in because of the interest differential," a dealer with a state-run bank said.
The central bank stunned investors on Tuesday by raising interest rates by 50 basis points, showing unexpected resolve in fighting persistently high inflation despite slowing growth in Asia's third-largest economy and uncertainty about global demand.
While the increase, the 11th since March 2010, dented the outlook for shares, traders are betting foreign funds will move into bonds and deposits lured by better yields.
Shares were subdued in choppy trade, with rate-sensitive sectors such as banks and automakers among the losers.
Traders said the rupee could face resistance at 43.80, as importers are likely to buy dollars around that level.
The dollar sank to a three-month low against a basket of major currencies on Wednesday as markets fretted about the prospect of a US debt default and downgrade, while they cautiously waited to see if Japan would intervene to weaken the yen.
The index of the dollar against six major currencies was down 0.05% at 73.438 points, and below 73.650 points when the rupee closed on Tuesday. The euro was trading at $1.4523, compared with $1.4480 previously.
The one-month onshore forward premium was at 24.50 points from 25.25 on Tuesday, while the three-month was at 75.50 points from 74.25 and the one-year was at 248.50 points versus 246.50.
One-month offshore non-deliverable forward contracts were quoted at 43.89, weaker than 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 at 43.8850. The total volume stood at $9.6 billion.