Asia FX

Is the Indian rupee on the brink of another violent downturn?

Dhiraj Singh | Bloomberg | Getty Images

As concerns over the Federal Reserve scaling back its monetary stimulus rise once again, is the Indian rupee at risk of repeating the violent selloff that took place in May-August?

The rupee has come under renewed pressure over the past two weeks, falling over 3 percent against the U.S. dollar to trade at a two-month low of 63.50 on Tuesday.

"The biggest factor seems to be the back-up in U.S. Treasury yields, the rupee is the most sensitive currency to U.S. yields in the emerging markets space," said Mitul Kotecha, head of global foreign-exchange strategy at Credit Agricole.

(Read more: Why Asian investors should not sweat an early taper)

"I don't think we're going to see a rush to the exit, but the pressure is going to continue going into next year," added Kotecha, who sees the currency depreciating to 64 by year-end, and 68 by the end of first quarter of 2014.

Indian markets' political euphoria

U.S. government bond yields have been on the rise driven by better-than-expected U.S. economic data, which has led to fears that the country's central bank could soon start tapering its $85-billion-per-month bond-buying program.

The 10-year U.S. Treasury note yield, for example, has climbed from 2.5 percent in late-October to 2.76 percent currently. Higher U.S. yields reduce the attractiveness of riskier, emerging market assets, such as the rupee.

On top of global forces, the rupee also faces headwinds domestically, as the Reserve Bank of India (RBI) unwinds some of the temporary measures put in place in late-August.

(Read more: Despite hiccup,rupee recovery likely to continue)

"The big issue is [the] RBI is no longer supplying as many dollars to state-owned oil companies as what it was - so now they have to go back to market to source their dollars. That's a concern as the oil companies are now more visible from a market perspective," said Jonathan Cavanagh, a currency strategist at Westpac.

Why this pro is optimistic on Rajan and the rupee

Last week, the country's economic affairs secretary Arvind Mayaram said state-run oil companies were sourcing 30-40 percent of their dollar needs in markets. Oil companies are the biggest buyers of dollars in markets, averaging around $300-350 million a day, according to traders' estimates cited by Reuters.

(Read more: Best performingcurrency in September? India's rupee)

However, Cavanagh notes that he does not foresee a replay of the brutal selloff seen this summer, when the currency came within a whisker of the key 70 level.

Foreign holdings of Indian government debt are 35 percent below levels back in May, so positioning from a bond market perspective is not as stretched, he said.

"The domestic situation is more positive than where we were a few months ago. Export growth is rising, the trade balance is better. There aren't as many negatives as there was 3-4 months ago. I'm not expecting a selloff like we saw in May," he added.

(Read more: India's October trade deficit jumps to $10.56 billion)

But Cavanagh acknowledges that a faster-than-anticipated back-up in U.S. yields does pose a risk for the currency.

"There's a risk that we could go back to the 65-66 level within a month if U.S. yields get back to 3 percent," he said.

—By CNBC's Ansuya Harjani; Follow her on Twitter:@Ansuya_H