* Rupee bounces as high as 66.85 from record low
* PM Singh says country faced with 'difficult' situation
* Trade minister floats idea of monetising gold
* Outgoing RBI governor defend central bank policies
By Rajesh Kumar Singh and Neha Dasgupta
NEW DELHI/MUMBAI, Aug 29 The Indian rupee rebounded on Thursday from a record low as the central bank sold dollars to oil companies, while policymakers scrambled for more lasting solutions to what some investors are describing as a crisis.
Among the steps debated by policymakers on Thursday were monetising the country's stash of gold and lowering fuel consumption to reduce import demand.
Prime Minister Manmohan Singh also told parliament he was likely to make a statement on the economy on Friday when asked by lawmakers what steps were being considered on the rupee.
Singh's ruling coalition has been under fire to revive an economy growing at the slowest rate in a decade, narrow a record current account deficit and shore up government finances - a daunting task ahead of general elections due by May.
"I cannot deny that the country is faced with a difficult situation," Singh said in brief remarks to the upper house of parliament on Thursday.
"There are some domestic factors. There are also some international factors arising out of change in U.S. monetary stance," he said, noting that rising tensions in Syria could drive up oil prices.
Although India has been hit by global factors such as concern over the Federal Reserve reining in its stimulus and the situation in Syria, few investors think these are the main problems for the rupee, which has fallen nearly 19 percent this year.
"It's a serious crisis of confidence and credibility. We could have managed things better," said Rahul Bhasin, managing director of Baring Private Equity Partners (India).
In the absence of major government action, the Reserve Bank of India, the central bank, has been the main defender of the currency, with a series of extraordinary measures including draining cash and curbing speculative trading.
Outgoing RBI Governor Duvvuri Subbarao defended the bank's action last month, calling it necessary to stabilise markets. But he said longer-term solutions, such as narrowing the country's current account deficit, lay with the government.
"The only lasting solution to our external sector problem is to reduce the CAD (current account deficit) to its sustainable level," Subbarao told industry and bank executives in Mumbai.
"Reducing the CAD requires structural solutions. RBI has very little policy space or instruments to deliver the needed structural solution. They fall within the ambit of the government," he added.
The RBI said late on Wednesday it was providing a special window with immediate effect to sell dollars to Indian Oil Corp Ltd, Hindustan Petroleum Corp, and Bharat Petroleum Corp Ltd.
The decision is aimed at removing a major source of dollar demand from the spot market.
The rupee strengthened to 66.85 per dollar, up sharply from a record low of 68.85 per dollar on Wednesday when the currency posted its biggest percentage fall in 18 years.
Thursday's rupee bounce also boosted shares and bonds, underscoring how movements in domestic markets are increasingly being driven by the beleaguered currency.
Surging prices for gold and oil could put more pressure on the current account deficit despite government action to curb India's two biggest imports.
Indian Trade Minister Anand Sharma said the RBI could monetise its gold reserves to reduce import demand for the precious metal but emphasized it was for the bank to decide.
Oil Minister Veerappa Moily said India was working on measures aimed at lowering fuel consumption. Oil is India's biggest single import item, so reducing domestic demand could cut imports and so ease pressure on the rupee.
Traders speculated the government might try to raise state-subsidised fuel prices to reduce oil demand.
India raised diesel prices in September, in a decision that cost Singh's ruling coalition its majority in parliament after partners bolted. The government followed up in January by allowing fuel retailers to gradually raise prices of diesel.
Upcoming elections have raised concern the government will lack the willpower to undertake reforms, as recent action suggests more of a populist bent that could worsen confidence in its fiscal discipline.
Parliament this week passed a 1.35 trillion rupee ($19.8 billion) government plan to provide subsidised grains to the poor, raising concerns about spending.
The Congress Party is next seeking to pass a controversial bill that would compensate farmers for land acquired for infrastructure and industrial projects, but which critics say could end up raising costs for companies.
"I think it's a horribly volatile situation, I think it just makes life miserable for all of us," said Rostow Ravanan, chief financial officer at Mindtree Ltd about the current corporate environment.
Indian bond yields have spiked, which threatens to drive up the government's borrowing costs.
While Brazil and Indonesia have raised interest rates to stem pressure on their currencies, similar action is seen as unlikely in India as it may undermine an already weak economy.
Subbarao, whose tenure ends next week, called for the central bank to maintain its defence of the rupee.
"There has been criticism that the Reserve Bank's policy measures have been confusing and betray a lack of resolve to curb exchange rate volatility. Let me first of all reiterate that our commitment to curbing volatility in the exchange rate is total and unequivocal," he said.
How the RBI continues to defend its measures will now be Raghuram Rajan to decide. The former chief economist of the International Monetary Fund will take over as the central bank head on Sept. 5.