By Subhadip Sircar and Swati Bhat
MUMBAI (Reuters) - The rupee surged 2.6 percent on Thursday, hitting its highest in nearly five weeks, as the U.S. Federal Reserve's decision not to dial back its easy money policy is expected to provide a reprieve to the Reserve Bank of India (RBI) in its policy making.
The rupee, which was among the top winners in Asia after the Fed move, and the Indonesian rupiah stand to gain the most if foreign funds return to riskier assets in the wake of the Fed's surprise decision. Both bore the brunt of the recent sell-off in emerging market currencies since the Fed bank signalled in May that it may begin tapering stimulus this year.
The BSE Sensex surged to its highest close in nearly three years, while bonds rose to their highest in a month.
The Fed's move also means that the RBI will have greater flexibility if it wants to roll back some of the cash tightening steps it initiated since mid-July to stabilise the plunging rupee.
The RBI's decision to bump up its emergency funding rate by 200 basis points to 10.25 pct and cap banks' borrowing from it roiled bond markets and pushed up corporate borrowing costs, adding to strains on the already slowing economy.
State Bank of India, the country's largest lender, on Thursday raised its base rate, or the lowest rate at which it lends, by 10 basis points to 9.80 percent.
"A delay in the tapering agenda paves the way for the RBI to relook at the liquidity tightening measures put in place in July and possibly ease the restrictions. With the rupee already halving the losses seen from May to August, there might not be sufficient justification to keep those measures to place," said Radhika Rao, economist at DBS in Singapore.
"The policy commentary could adopt a move dovish and growth-supportive stance," she said, referring to the RBI's policy announcement after its meeting on Friday.
The partially convertible rupee closed at 61.77/78 per dollar compared to its close of 63.38/39 on Wednesday. The unit rose as high as 61.64, its strongest since August 16.
Bonds rallied with the benchmark 10-year yield falling to 8.14 pct, its lowest since Aug 8. It closed at 8.19 percent, down 18 bps. The Sensex and the Nifty closed more than 3 percent up.
"It is too early to say that everything is rosy for INR as global factors have played in favor of INR. We have to wait for tomorrow's policy to take a more concrete view," said Paresh Nayar, head of fixed income and currencies trading at First Rand Bank in Mumbai.
RBI Governor Raghuram Rajan will detail monetary policy on Friday and is widely expected to keep the policy rate and the cash reserve ratio unchanged, according to a Reuters poll. The poll, which was conducted before the Fed decision, also expects the July cash tightening steps to be retained.
A resurgence of inflation to a six-month high in August has muddied waters for the central bank, which has been battling a falling rupee and trying to revive the economy with growth having slumped to a decade low.
(Additional reporting by Archana Narayanan; Editing by Kim Coghill and Sunil Nair)