The rupee pared early gains on Wednesday as investors squared positions ahead of a market holiday and uncertainty about the near term trend for the Indian unit.

The partially convertible rupee closed at $40.30/31, a shade stronger than Tuesday's 40.31/32 but weaker than an intraday peak of 40.21.

It had fallen to a five-month low of 40.40 on Monday. Financial markets are closed on Thursday for a local holiday. "It has been a ranged session with banks covering their short-dollar positions and state-run banks stepping on the bid at lower levels on the dollar/rupee," said LV Prasad, head of currency trading at Mumbai-based IndusInd Bank.

Dealers said volumes remained thin as exporters were unsure about the Rupee's near term outlook due to a dollar shortage in the banking system. Capital outflows and a curb on offshore loans by policymakers have slowed the supply of dollars.

Foreigners have sold more than $3 billion of shares so far in 2008 after buying $17.4 billion in 2007. Last August, the finance ministry curbed foreign borrowings by companies to halt a surge in dollar inflows, which was putting upward pressure on the rupee at that time.

On Wednesday, Finance Minister P Chidambaram said these restrictions were intended to be only temporary and that the government had not shut down foreign borrowings. "We will see when that happens.

At the moment the currency markets are facing a chronic dollar shortage," said a dealer at a foreign bank. But some analysts expect the rupee to rise later in the year as the RBI raises rates to tackle accelerating inflation.

DBS said on Wednesday expects the RBI to raise interest rates by 50 basis points in the second half of 2008 and forecast the rupee to rise to 36 by the end of the year.

Technorati Tags: Finance