Rupee rallies, but tough outlook intact

MUMBAI (Reuters) - The rupee rallied on Friday on expectations that a global risk rally would help curb the recent heavy selling by foreign investors, while the government's push to raise gas prices raised prospects for more fiscal and economic reforms.

The recovery in the rupee from a record low of 60.76 hit on Wednesday boosted government bonds, leading the fixed income association to widen trading bands for the day - a contrast to recent weeks when the same action was taken to counter a sharp fall in the debt market.

The gains are a welcome end to a tough month for Indian markets, which have been caught in a negative feedback loop in which the falling rupee sparked across-the-board foreign selling, with the outflows in turn further denting the currency.

Yet, few analysts are willing to call a bottom for the currency, which has slumped over 10 percent in the April-June quarter, its biggest quarterly fall in at least nine years.

"The rupee is seeing a recovery as it had overshot 60 because of panic in the market. It may remain supported for the next few sessions on inflows, but there is more downside left for the currency," said Param Sarma, chief executive at NSP Forex.

The Indian rupee was trading at 59.76/77 compared with its previous close of 60.19/69.20. The benchmark 10-year bond rose, with yield falling 8 basis points from the previous close.

Shares also rallied, with the Nifty up 1.9 percent, led by energy firms such as Oil and Natural Gas Corp and Reliance Industries , which would most benefit from higher gas prices.

Investors welcomed a global risk rally sparked by reassuring comments from several officials of the U.S. Federal Reserve that any tightening of its stimulus drive was still a distant prospect.

India's approval of a gas price rise for the first time in three years was seen as a positive signal, raising hopes the government would also announce other potentially unpopular moves, such as opening up more sectors to foreign investment.

Attracting foreign flows is critical for India after its current account deficit hit a record high 4.8 percent of gross domestic product in the fiscal year that ended in March. That has made the country more vulnerable than other emerging markets.

Foreign investors have sold a net $7 billion in bonds and shares so far this month, further raising the stakes.

Sizeable outflows from the equity and debt markets since late May have rekindled concerns about the balance of payments position, said Radhika Rao, an economist with DBS Bank in Singapore.

(Reporting by Rafael Nam and Subhadip Sircar; Editing by Prateek Chatterjee)