While capital outflows weighed on the rupee, positive local stocks helped to limit the fall, a forex dealer said.
At the interbank foreign exchange market, the rupee opened lower at 61.65 a dollar from Monday's close of 61.52 and declined further to a low of 61.7150.
However, the local currency bounced back to a high of 61.4250 before closing at 61.54, a fall of two paise.
Support for the rupee came as local stocks advanced after wholesale inflation eased to a five-month low in December, raising hopes the Reserve Bank will keep interest rates on hold.
The dollar gained overseas after a stronger-than-expected report on US retail sales indicated the Federal Reserve could continue to slow the rate of its monthly bond purchases.
The benchmark 30-share Sensex surged 256.61 points, or 1.22 per cent, to 21,289.49, the highest closing since ending at a record 21,326.42 on December 9. Overseas investors sold shares worth a net Rs 260.88 crore yesterday, according to provisional data.
"The dollar index, which measures the US currency's value against a basket of six major currencies, traded strong throughout the day," said Pramit Brahmbhatt, CEO of Alpari Financial Services (India).
"But in the second session, the rupee recovered and closed near the previous day's level with the help of local equities, which ended on a positive note," he said.
Forward dollar premiums remained weak on sustained receipts by exporters.
The benchmark six-month forward dollar premium payable in June eased to 229-231 paise from 230-1/2 to 232-1/2 paise previously.
Far-forward contracts maturing in December slipped to 463-1/2 to 465-1/2 paise from 465-467 paise.
The RBI fixed the reference rate for the dollar at 61.5885 and for the euro at 83.9915.
The rupee strengthened to 101.11 against the pound from 101.20 and hardened to 83.85 per euro from 84.06.
It recovered to 59.03 per 100 Japanese yen from 59.50.