Rupee seen posting worst quarter in at least 17 years

Fiscal and current account deficits might leave the rupee vulnerable to capital outflows

The rupee strengthened on Friday after the government confirmed it won't impose retroactive taxes on foreign investors and as global risk asset rallied, but still headed for its worst quarterly performance in at least 17 years.

Euro zone leaders agreed on Friday to take emergency action to bring down Italy's and Spain's spiralling borrowing costs and to create a single supervisory body for euro zone banks by the end of this year, a first step towards a European banking union.

The improved global risk environment comes as investors are growing more hopeful of meaningful policy reforms at home after Prime Minister Manmohan Singh, a former RBI governor, took charge of the finance ministry.

The government released draft rules on Thursday and said the general anti avoidance rules, or GAAR, would not apply retroactively, a big concern for portfolio investors.

"The INR may outperform as well as India seems to be backtracking on its plans to retroactively apply new tax rules that would penalize a major foreign direct investor," said Dariusz Kowalczyk, senior economist & strategist for Asia ex-Japan at Credit Agricole.

At 12.05 p.m., the rupee was at 56.29/31, and headed for its biggest weekly gain in five months.

That marked a turnaround after the rupee tumbled to a record low of 57.32 against the dollar a week ago. The currency is on course to log it worst quarter in at least 17 years, as per available Reuters data, having first started to tumble to set record lows in May.

India has been buffeted by various macroeconomic concerns, primarily the twin fiscal and current account deficits, leaving it vulnerable to capital outflows at a time of global risk aversion.

However, with Singh, widely credit with ushering in economic reforms in India in the 1990s, taking charge of the finance portfolio, investors are hoping he will push some much awaited reforms and address concerns on tax issues.

Global risk aversion has also improved. The euro surged following relief after the statement from European leaders, raising hopes it could help ease a big recent overhang in global markets.