Sept. 20 (Bloomberg) -- India's rupee strengthened beyond 40 per dollar for the first time in nine years as a U.S. interest-rate cut prompted investors to seek higher returns in the world's second-fastest-growing major economy.

The rupee is Asia's best-performing currency this year, climbing 11 percent, as share purchases by overseas investors surpassed the total for 2006. The benchmark Bombay Stock Exchange Sensitive Index, or Sensex, has climbed 4.3 percent to a record since the Federal Reserve's Sept. 18 rate cut.

``The Fed's rate-cut is the key reason for a rupee rally,'' said Richard Yetsenga, a strategist at HSBC Holdings Plc in Hong Kong. ``The authorities in India will undertake policies periodically to slow the move, but there isn't much anybody can do about the ultimate direction.''

The rupee surged 0.8 percent to 39.8825 against the dollar, the highest close since May 13, 1998, according to data compiled by Bloomberg. Yetsenga expects the currency to rise to 39 by the end of the year and to 37.5 by December 2008.

The currency's rally had slowed after it breached 41 to the dollar in April as the central bank sold the rupee and global investors shunned emerging market assets because of a deepening credit market slump. The currency has risen 1.5 percent since the Fed's decision to cut rates, which reduced investor concern that global economic growth will slow.

The Reserve Bank of India said on Sept. 14 it intervenes in currency markets, arranging purchases or sales of foreign exchange to contain volatility. The central bank bought $11.4 billion in July, the most since February, central bank data show.

Exporters Hurt

``The government's measures to curb the rupee have thus far been half-hearted,'' said Ganesh Kumar Gupta, president of the Federation of Indian Export Organisations in New Delhi. ``If the rise in the value of the rupee continues, 8 million people are likely to lose their jobs by the year-end.''

Indian Trade Minister Kamal Nath said in New Delhi the gain in the rupee is a cause for concern and the government will consider granting some form of subsidy to exporters.

``Exports are the engine of growth and we have to ensure that growth isn't affected,'' Nath told reporters. ``It is a new situation and a new situation requires a new response.''

The central bank will probably intervene as the currency rises to 39.50, said Y.M. Deosthalee, the chief financial officer of Mumbai-based Larsen & Toubro Ltd., India's biggest engineering company.

``An appreciating rupee will reduce our competitiveness,'' said Ramesh Rajah, president of India's Coffee Exporters Association. ``Exports are already down 10 percent this year and the trend may not be reversed anytime soon.''

India, Asia's third-biggest coffee exporter, ships two- thirds of its annual output of about 300,000 tons overseas.

`Matter of Concern'

``It is a matter of concern,'' said N.R.K. Raman, chief executive officer of I-Flex Solutions Ltd., an Indian computer- software company controlled by Oracle Corp. ``We are taking steps, including improving efficiency and productivity, to counter the rise of the rupee.''

The Federal Reserve cut its benchmark rate by half a point to 4.75 percent, the first reduction in four years, to prevent the world's biggest economy from sliding into a recession and to restore confidence in credit markets.

Overseas funds bought $9.5 billion of Indian equities more than they sold this year, compared with $8 billion in all of 2006, according to the Securities & Exchange Board of India.

``Even in the event of a slowdown in the U.S., we think India is a good story,'' said Irene Cheung, Singapore-based strategist at ABN Amro NV. ``The appetite for risk is coming back.''

Rupee Forecast

The rupee may rise to 39 by the end of 2008, Cheung said. The median forecast of 19 strategists Bloomberg surveyed is 40.

The spread, or the yield difference, between a 10-year U.S. Treasury note and a similar-maturity Indian government bond has widened to 3.29 percentage points from 2.77 percentage points on July 18, Bloomberg data show.

Growth in Asia's fourth-biggest economy unexpectedly accelerated in the quarter ended June 30 to 9.3 percent. Only China's 11.9 percent growth was faster among the world's 20 largest economies.

Central bank Governor Yaga Vengupal Reddy has increased the repurchase rate six times since the beginning of 2006 to 7.75 percent, a five-year high.

The pace of the currency's rally may slow as the central bank buys dollars, said Indranil Pan, chief economist at Mumbai- based Kotak Mahindra Bank Ltd. Rising imports, especially fuel purchases, are also a threat to the advance, he said.

India's trade deficit widened to $38.2 billion in the seven months through July from $26.1 billion a year earlier, according to government data.

The euro is more important to India than the dollar because the European Union accounts for 40 percent of exports, said Sebastian Barbe, a strategist at Calyon in Hong Kong. The rupee has weakened 0.8 percent against the euro in the past month.

``The Reserve Bank is also looking at the currency on a trade-weighted basis,'' Barbe said.

To contact the reporter on this story: Sam Nagarajan in New Delhi at samnagarajan@bloomberg.net.

Last Updated: September 20, 2007 08:07 EDT