By Rafael Nam and Abhishek Vishnoi
MUMBAI (Reuters) - The Indian rupee rebounded on Thursday from a record low as the central bank's action to sell dollars to oil companies provided relief for the currency, albeit one seen unlikely to last unless the government acts to shore up a sagging economy.
Policymakers scrambled for solutions to what some economists are now describing as a crisis. These included monetizing the country's stash of gold and lowering fuel consumption to reduce import demand.
Prime Minister Manmohan Singh told parliament he was likely to make a statement on the economy on Friday when asked by lawmakers what steps were being considered on the rupee.
Singh's ruling coalition has been under fire to revive an economy growing at its slowest pace in a decade, narrow a record current account deficit, and shore up government finances - a daunting task ahead of general elections due by May.
"I cannot deny that the country is faced with a difficult situation," Singh said in brief remarks to the upper house of parliament on Thursday.
"I don't deny there are some domestic factors. There are also some international factors arising out of change in U.S. monetary stance," he said, while noting rising tensions in Syria could have negative implications for oil prices.
Although India has also been impacted by global trends - mainly fears of Federal Reserve reining in its monetary stimulus and the Syria tensions - few investors believe they are the biggest factors impacting a currency down nearly 19 percent this year.
"It's a serious crisis of confidence and credibility. We could have managed things better," said Rahul Bhasin, managing director of Baring Private Equity Partners (India).
In the absence of significant government action so far, the Reserve Bank of India (RBI), the central bank, has become the country's main line of defense against the currency.
The RBI said late on Wednesday it was providing a special window with immediate effect to sell dollars to Indian Oil Corp Ltd <IOC.NS>, Hindustan Petroleum Corp <HPCL.NS>, and Bharat Petroleum Corp Ltd <BPCL.NS>.
The decision is aimed at removing a major source of dollar demand from the spot market - worth $400 million to $500 million daily - and so reduce downward pressure on the Indian currency.
The rupee rose as high as 66.85 per dollar shortly after the open, up sharply from a record low of 68.85 per dollar on Wednesday when the currency posted its biggest single-day percentage fall since October 1995.
Thursday's rupee bounce also boosted shares and bonds, underscoring how movements in domestic markets are increasingly being driven by the beleaguered currency.
India's main NSE share index <.NSEI> rose as much as 2.1 percent while benchmark 10-year bond yields fell 15 basis points to 8.81 percent.
Sentiment was also helped by a recovery in Asian shares while emerging market currencies stabilized as worries eased that U.S.-led forces would launch an immediate military strike against Syria.
Brazil and Indonesia raised interest rates to stem pressure on their currencies, but similar action is seen as unlikely in India for fear it would undermine an already weak economy.
Pressure on the government to act is rising as an RBI plan unveiled last month to drain cash from markets has pushed up bond yields, raising borrowing costs.
Meanwhile, surging prices for gold and oil could put more pressure on the current account deficit despite government action to curb India's two biggest imports.
In the latest suggestion to try to narrow the yawning gap, Indian Trade Minister Anand Sharma said the RBI could monetize its gold reserves to reduce import demand of the precious metal and dollar outflows. He emphasized it was for the central bank to decide.
Oil Minister Veerappa Moily said India was working on measures aimed at lowering fuel consumption. Oil is India's biggest single import item, so reducing domestic demand could cut imports and so ease pressure on the rupee.
Traders speculated the government might try to raise state-subsidized fuel prices to reduce oil demand.
India raised diesel prices in September, in a decision that cost Singh's ruling coalition its majority in parliament after partners bolted. The government followed up in January by allowing fuel retailers to gradually raise prices of diesel.
Yet upcoming elections are raising concerns the government will lack the willpower to undertake reforms.
"If the rupee continues to depreciate there would not be any choice," said Paras Adenwalam, principal portfolio manager at Capital Portfolio Advisors.
"But the question is, with the election around the corner, how much can they hike," he said. "To change India's picture, the price hikes have to be very large, and that is not going to happen."
To the contrary, government action suggests more of a populist bent that could worsen confidence in its fiscal discipline.
Parliament this week passed a 1.35 trillion rupee ($19.81 billion) government plan to provide subsidized grains to the poor, raising concerns about spending.
The Congress Party is next seeking to pass a controversial bill that would compensate farmers for land acquired for infrastructure and industrial projects, but which critics say could end up raising costs for companies.
"I think it's a horribly volatile situation, I think it just makes life miserable for all of us," said Rostow Ravanan, chief financial officer at Mindtree Ltd <MINT.NS> about the current corporate environment.
Ravanan added any benefits on overseas trade from a weaker currency for the software service exporter based in Mumbai was offset by the current uncertainty.
"One quarter maybe you'll get some temporary benefit. But beyond that, our largest cost is people cost, and with the implication of the rupee the way it's going, inflation will go out of control and obviously salary costs will also go out of control."
(Additional reporting by Suvashree DeyChoudhury; Editing by Neil Fullick)