The rupee plummeted to a record low against the dollar on Monday, leading a rout by Brazil's real and other emerging market currencies seen by investors as the most vulnerable to an exodus of foreign capital.
A fierce selloff in many emerging currencies shows no sign of abating as the expected withdrawal of US monetary stimulus prompts investors to shun markets seen as riskier because of funding deficits, slowing economies and inflation.
The rupee fits that bill, as do the Indonesian rupiah, the South African rand and the Brazilian real. The rupiah plunged to four-year troughs on Monday while the rand lost another 1% to bring year-to-date losses to almost 17% against the dollar.
Brazil's real extended last week's fall of more than 5% fall to trade at its weakest level since March 2009 even as the central bank sold nearly $3 billion worth of currency swaps, which are derivatives that mimic an injection of dollars in the futures market. Like the rupee, it has been hammered by doubts over the efficacy of policy actions to stem the rout.
The rupee and the real, respectively, have been the worst performers in Asia and Latin America since late May when the Fed first signalled that it may begin winding down its monetary stimulus this year.
India's currency has lost 13% against the dollar this year while the real has plunged 15% in the same period.
A decline in the Fed's bond purchases will push government debt yields higher, which should raise the attractiveness of the dollar and dollar-denominated assets.
In Brazil, the currency weakness has complicated policymakers' efforts to rein in inflation, leading many investors to bet the central bank may speed up the pace of monetary tightening next week.
In India, the rupee's sell-off threatens to drive Asia's third-largest economy towards a full-blown crisis.
"Our primary concern is that the policy authorities still don't 'get it' - thinking this is a fairly minor squall which will simmer down relatively quickly with fairly minor actions," Robert Prior-Wandesforde, an economist at Credit Suisse in Singapore, wrote in a note on the Indian currency on Monday.
The partially convertible rupee has continued to weaken despite the central bank's dollar sales and its latest curbs on outflows from companies and individuals, announced last Wednesday, which have dented India's stock and bond markets.
As the global flow of cheap money wanes, many emerging markets are feeling the heat. Among the most vulnerable to sudden capital flight are the currencies of countries already struggling with wide current account deficits, such as India and Indonesia.
"The market is still acting on the negative current account and fiscal deficits," said Nizam Idris, a strategist with Macquarie Capital, when asked about the two Asian laggards.
The latest blow for the Indonesian rupiah came late on Friday when central bank data showed the current account deficit jumped to 4.4% of GDP in the second quarter of the year, from 2.4% in the previous quarter.
South Africa's central bank, unlike its peers, has not stood in the way of the rand's weakness.
The rand hit a five-week low at around 10.2 per dollar on Monday as Fed-fuelled headwinds were exacerbated by fresh labour strife and upcoming Chinese data that is expected to paint a picture of weaker growth in South Africa's biggest export market.
"They have very weak growth but can't cut interest rates so they are using the currency as the lever," said Guillaume Salomon, a strategist at Societe Generale in London.
The risk for these so-called deficit economies is that as global liquidity is reeled back by the Fed, weakness in the real or the rupee will force investors to flee stocks and bonds. That could exacerbate the currency selloff in a self-perpetuating vicious cycle leading potentially to balance of payments crises.
All these countries rely heavily on foreign capital inflows to plug current account gaps that range from 3% in Brazil and 4.8% in India to 6.5% in South Africa.
"India and South Africa are the two currencies that are most at risk. As long as the currency trades with a weak bias, concerns about outflows will remain," Salomon of Societe Generale said.
Those fears are now evident in financial markets, with Indian equities sliding nearly 2% and 10-year borrowing costs rising above 9% to the highest since 2008. Stocks in Jakarta fell 3% and bond yields surged to March 2011 peaks. South African yields were at their highest in over a year.
Markets are waiting to see what else Brazil's central bank can do to reassure investors after an estimated $30 billion worth of intervention this year via currency swaps. So far, however, Brazilian policymakers seem unwilling to deplete their $370 billion foreign reserves to fight a global depreciation trend.
As in India, Brazil's previously fast-growing economy has slowed, disappointing investors and Brazil, like Indonesia, has seen a sharp deterioration in its balance of trade due to a cooling in China's appetite for commodities.
Other Latin American currencies, despite being seen as less vulnerable than the real, have also weakened sharply in the past few days. The Mexican peso lost about 1% on Monday after sliding 2.3% last week. Chile's peso, which is strongly correlated to copper prices, dropped 1% on Monday to close at its weakest level in more than a year.