The rupee appreciated 18 paise to close at 81.18 (provisional) against the US dollar on Friday on broad dollar weakness.
However, weak domestic equities and a surge in crude oil prices capped sharp gains for the local currency, forex traders said.
At the interbank foreign exchange market, the local unit opened strong at 81.24, and settled for the day at 81.18 (provisional), registering a rise of 18 paise over its previous close.
During the trading session, the local unit witnessed an intra-day high of 81.09 and a low of 81.28 against the American currency.
On Thursday, the rupee closed at 81.36 against the US dollar.
The dollar index, which gauges the greenback's strength against a basket of six currencies, advanced 0.21 per cent to 102.26.
Global oil benchmark Brent crude futures rose 0.48 per cent to USD 86.57 per barrel.
According to Anuj Choudhary - Research Analyst at Sharekhan by BNP Paribas, the Indian rupee appreciated on Friday on soft US dollar and FII inflows on Thursday.
"Dollar declined on increasing odds of a 25-bps rate hike by FOMC following disappointing economic data coming out from the US," Choudhary said.
The US Federal Reserve Vice Chair Lael Brainard hinted that the US Fed may hike rates at a slower pace by 25 bps in the next Federal Open Market Committee (FOMC) meeting in February and is expected to hold higher rates for longer to tame inflation.
"We expect the rupee to trade with a positive bias on a weak tone in the greenback. However, concerns over global economic growth and a surge in crude oil prices may cap a sharp upside.
"Traders may focus on existing home sales data and comments from FOMC members. USD/INR spot price is expected to trade in a range of Rs 80.50 to Rs 81.80," Choudhary said.
On the domestic equity market front, the 30-share BSE Sensex declined 236.66 points or 0.39 per cent to end at 60,621.77, while the broader NSE Nifty fell 80.20 points or 0.44 per cent to 18,027.65.
Foreign Institutional Investors (FIIs) were net buyers in the capital market on Thursday as they purchased shares worth Rs 399.98 crore, according to exchange data.