The Indian rupee fell through 65 to the dollar to a record low on Thursday, after Federal Reserve minutes hinted the United States was on course to begin tapering stimulus as early as next month and as foreign investors become sellers of Indian stocks.
In an ominous sign for Asia's worst-performing currency this year, overseas investors, who had been net buyers of Indian stocks so far in 2013, headed for the exits this week, selling a net amount of more than $700 million worth of shares in the five sessions through Thursday.
Foreigners have also sold a net amount of nearly $1 billion of Indian government and corporate bonds so far this month.
"Unless growth signals emerge in the next few quarters, foreign institutional investors will continue to pare down Indian equities, which will weigh on the rupee," said Deven Choksey, managing director of KR Choksey Securities.
Indian stocks, however, snapped a four-day losing streak, with the benchmark BSE index ending up 2.27 percent despite continued selling by foreign institutions.
The rupee fell as much as 2 percent to 65.56 to the dollar, before recovering losses to close at 64.55/56, a sixth straight session of declines, and is down 14.8 percent so far this year despite policymakers' efforts to prop it up.
Finance Minister P. Chidambaram sought to lift confidence, telling a news conference that while economic growth remained flat in the first quarter of the fiscal year ending March 2014, it was likely to pick up in the remaining three quarters.
"We are in better health than many other countries in the world," he said in New Delhi. "Therefore there is no reason for excessive or unwarranted pessimism."
Currencies in Indonesia, Malaysia and Thailand all hit multi-year lows on concerns that the Fed's scaling back of stimulus would trigger further capital outflows from emerging markets, which have benefited for the last two years from waves of cheap money printed by Western central banks.
Ratings agency Fitch warned that governments in India and Indonesia, also facing a crisis of confidence among investors, needed to halt the slide in perception.
India's credit rating is one notch above junk grade.
"Rapid private-sector credit growth, widening fiscal deficits or sustained higher inflation could lead to a broader and more sustained loss of confidence among investors," Fitch said in a statement on India and Indonesia.
"This could potentially undermine economic and financial stability, and ultimately lead to negative rating action."
Rupee buyers in the forex market seemed to be drying up, with the central bank suspected to have intervened in the last several sessions to support the currency, including late in Thursday's session.
Some strategists made increasingly bearish calls on the rupee, with Credit Agricole saying that unless capital flows returned, it did not see the fundamental value for the rupee below 70 to the dollar and would not recommend buying it for fundamental reasons below 75. Deutsche Bank said on Wednesday the rupee could fall to 70 in a month or so.
The 1-month offshore non-deliverable forward contract was quoted at 65.60 compared to the onshore one-month forward of 65.07, suggesting offshore players are betting against the rupee.
The Reserve Bank of India's efforts to support the currency have failed to do so but have sent bond yields surging, pushing up borrowing costs and undermining an economy that grew at its weakest in a decade in the last fiscal year to March 2013.
ICICI Bank, the country's second-largest lender, became the latest to raise interest rates, lifting its base rate by 25 basis points to 10 percent, effective Friday.
A weak coalition government facing national elections by May has been unable to push through structural reforms to lure long-term foreign investment, with the current parliamentary session all but paralysed by political bickering.
"Barring a galvanising economic crisis, pending tax, land acquisition and insurance reforms will likely be delayed for several years, providing no respite for India's faltering economy," Eurasia Group analyst Anjalika Bardalai wrote.
In what was seen as a partial roll-back considered by some market participants to have sent a mixed message, the RBI took steps on Tuesday to support a bond market hurt by its rupee defence.
Bond prices continued to recover on Thursday, with yields ending down 18 basis points at 8.23 percent.
Some analysts said the RBI's move was similar to the Fed's "Operation Twist" begun in 2011 to buy long-end bonds.
"Policymaking is essentially in a quandary, as the framework comprises of multiple and often conflicting objectives," said Radhika Rao, economist at DBS Bank in Singapore.
"To this end, a single-minded focus on correcting the currency's course entails collateral damage - dampens equity and bond markets and carries risks to growth," she added.