Rupee hit by worries of rollback on reforms

Kashmiri college girls walk under garlands made of rupee notes on display at a market in Srinagar September 3, 2012.

MUMBAI (Reuters) - Rupee fell to its lowest in nearly a week on Thursday as a key ally of the country's ruling coalition withdrew its support, raising worries the government may roll back big ticket reforms such as the hike in diesel prices.

Prime Minister Manmohan Singh's government is widely expected to survive the blow to its parliamentary strength.

However, the planned withdrawal by the Trinamool Congress, which is opposing the diesel and retail reforms announced last week, will put the fate of the government in the hands of smaller parties.

Investors are worried India will retreat on some of its measures and fear the political crisis could threaten future reforms in sectors such as pension and insurance, although for now they expect the government to hold its ground.

"I don't see any rollback of recent measures. Probably we may not see follow-on measures for some time, it is neither bullish nor bearish at this moment; hence look for consolidation in rupee at 53.65-54.50," said Moses Harding, head of asset-liability management at IndusInd Bank.

The partially convertible rupee ended at 54.3850/3950 to the dollar from its Tuesday close of 54.01/02. Markets were closed on Wednesday because of a religious holiday.

The rupee fell to a session low of 54.42, its lowest since September 14.

Local stocks also fell, with the benchmark Sensex ending down 0.8 percent, after foreign investors had pumped in 62.62 billion rupees in net inflows over the previous three sessions.

The rupee has gained over 2 percent since the government announced a steep hike in diesel prices and permission for foreign direct investment into multi-brand retail sector.

The local unit could remain volatile in the days ahead, as investors track political developments.

UBS called Trinamool's withdrawal "political theatre", but warned they could threaten the government's reform initiatives.

Trinamool's decision "raised not only political entropy but also the risk that announced measures may be either diluted or delayed," UBS said in a noted dated on Wednesday.

USD/INR 1-month non-deliverable forwards were bid and last trading at 54.60 versus its previous close of 54.49.

In the currency futures market, the most-traded near-month dollar/rupee contracts on the National Stock Exchange, the MCX-SX and the United Stock Exchange all closed at around 54.365 with a total traded volume of around $4.5 billion.

(Editing by Rafael Nam)