The rupee gained 66 paise in trade or 1.1 per cent following the RBI move late on Monday. The Indian currency was last trading at 59.26 against the dollar.
The RBI decision to hike the MSF is to ensure that speculators do not short the Indian currency, which would then give a big boost to the rupee.
The Indian rupee has been one of the worst performing Asian currencies in the last few months, thanks to a high current account deficit.
"The market perception of likely tapering of US Quantitative Easing has triggered outflows of portfolio investment, particularly from the debt segment. Consequently, the Rupee has depreciated markedly in the last six weeks. Countries with large current account deficits, such as India, have been particularly affected despite their relatively promising economic fundamentals. The exchange rate pressure also evidences that the demand for foreign currency has increased vis-a-vis that of the Rupee in part because of the improving domestic liquidity situation, the RBI said in its statement.