But where there are bulls there are also bears and for them a widening current account deficit is one reason not to get carried away with optimism about the rupee following Tuesday's 2006/07 budget.

The rupee strengthened to a two-week high at 44.25 per dollar on Wednesday, almost one percent stronger than seven-week lows struck last week.

Dealers said for now at least the rupee was likely to firm and could go to 44.00 by the end of the month--a level unbreached since September--as investors focus on positive budget measures like a rise in the amount foreigners can invest in government bonds and a lower-than-expected fiscal deficit.

"One of the most important positives for the rupee from the budget is the commitment to bringing down the fiscal deficit," said Shuchita Mehta, chief economist, India, at Standard Chartered in Mumbai.

"There has also been a freeing up of the ceiling on investment in the bond market, while strength in the yen (against the dollar) is also good for the rupee. On the negative side there is a huge current account deficit," she said.

Finance Minister P Chidambaram raised the cap in foreign investment in government bonds to $2 billion from $1.75 billion. The corporate debt limit was trebled to $1.5 billion.

He said the 2005/06 Union fiscal deficit would come in lower than expected at 4.1 per cent of gross domestic product and set a deficit goal of 3.8 per cent for the 2006/07 fiscal year. If achieved, this would be the lowest since reforms began in 1991.

RATINGS UPGRADE?

Over the long term, the rupee was expected to gain from any improvement in India's fiscal position, especially if it led to an upgrade of the country's credit rating.

Fitch Ratings and Standard & Poor's rate India one notch below investment grade while Moody's Investor Services gives its foreign currency rating an investment grade. But Moody's also puts the local currency rating at 'Ba2', below investment grade, because much of the debt is in rupees.

"Long term, if fiscal prudence is continued, there could be a re-rating in India and this would be positive for the currency," said ICICI Bank chief economist Samiran Chakraborty.

Analysts said the outlook for continued strong growth in India, Asia's third-largest economy, and higher interest rates may also put upward pressure on the rupee.

But more important was the prospect of foreign demand for local stocks, which could outweigh the impact of the widening current account deficit. Foreign investor inflows of more than $10 billion were a significant support to the rupee in 2005 as the current account fell further into deficit.

The Prime Minister's Economic Advisory Council said last week the current account deficit for this financial year would be 2.9 per cent of GDP, after a 0.9 per cent deficit last year.

STOCKS STILL KEY

The main stock index hit a record high on Wednesday, lifting expectations that net foreign fund buying of local shares--already above $2 billion so far this year--will continue.

"The budget is not too significant for the rupee. What is important is the equity market, the current account deficit and the dollar trend. We have seen strong portfolio inflows into India and this has gone on unabated in recent months compared to the rest of Asia," said Mirza Baig, a currency analyst at Deutsche Bank in Singapore.

If current account worries do not keep rupee gains in check, the RBI will, dealers said. The RBI intervenes through state-run banks to calm volatility and if it thinks a firm rupee will harm exports.

"The nationalised banks have been buying dollars today and this could be for the RBI (Reserve Bank of India). It would make sense as there have been strong flows coming through," said a dealer at a foreign bank in Mumbai.