The downward spiral in the Indian rupee poses a significant threat to the country's equity market, according to one strategist, who warns that continued weakness in the currency could prompt foreign investors to flee domestic stocks.
The weak rupee has depreciated 10.8 percent against the U.S. dollar this year, making investment returns less attractive for foreign investors, who are a major driving force in the market.
"When an emerging market currency does not respond positively to policy liquidity tightening, the market is in deep trouble. Therefore, further price weakness in the currency could plausibly drive further weakness in the equity market," said Nicholas Ferres, investment director, global asset allocation at Eastspring Investments, referring to the Reserve Bank of India's recent measures to tighten liquidity in order to make it more difficult to speculate against the currency.
(Read more: Is India's rupee back in the danger zone?)
"Indian equities may be a slow moving train wreck that is close to derailment," he said.
Despite growing risks to the outlook for Indian stocks, they have held up better than other emerging market peers. The benchmark Sensex index has declined 3.6 percent year-to-date, compared with the Shanghai Composite, for example, which has lost 9.2 percent.

