Indian stocks hit a high for the year yesterday and the rupee clawed back some of its losses on hopes that the government will push ahead with its economic reform initiatives.
There has been a logjam in parliament this week, with opposition parties calling for a vote over whether to allow foreign direct investment (FDI) in the nation's supermarkets and disrupting proceedings.
But the government yesterday agreed to the vote and there was optimism that retail reform had significant support.
Indian stocks hit their highest level since May last year with the Bombay Stock Exchange benchmark Sensex surging above the 19,000 level.
The rupee had weakened more than 1 per cent in recent sessions, closing at a near three-month low of 55.73 against the US dollar on Monday. But yesterday it strengthened, trading below 55 against the dollar.
A wave of reforms has been launched by the government to spur foreign investment and boost economic growth.
"The opposition has its own agenda - to unwind recent legislation introduced by the government," said HSBC in a recent report.
"The key reforms they are looking to push back on are the approval of FDI in multi-brand retail and the recent fuel subsidy reforms, including limiting the available amount of subsidised LPG [liquefied petroleum gas] cylinders and the diesel price hike.
"If we were to a see a reversal of some of these recent reforms, it would undoubtedly put increasing weakening pressure on the Indian rupee."
The rupee strengthened slightly against the dollar on Tuesday after the ratings agency Moody's said that it had kept a stable outlook on India's Baa3 sovereign rating, "supported by credit strengths which include a large, diverse economy, strong GDP growth as well as savings, and investment rates that exceed emerging market averages".
But Moody's added that "the rating is constrained by the credit challenges posed by India's poor social and physical infrastructure, high government deficit and debt ratios, recurrent inflationary pressures and an uncertain operating environment".
Standard & Poor's has also warned that India was at risk of being downgraded to junk status.
"What matters now is how effective the government will be in maintaining the course for its (much-needed) reform agenda," said HSBC.
"If India is unable to pass reforms to open up its investment sector and make it more attractive to foreign funding, then the large twin deficits will continue to weigh on the currency."