The Indian rupee lost 1.5% on Wednesday, suffering its biggest single-day fall in 20 months as the central bank mapped out plans for a massive government bond buying programme.
The partly convertible currency ended at 74.55 per dollar versus its previous close of 74.43, having earlier touched 74.5550, its weakest since Nov. 17.
The Reserve Bank of India (RBI) kept interest rates at record lows on Wednesday but its commitment to government bond purchases raised prospects of plenty of rupee liquidity, and potential inflation, both of which undermined sentiment toward the currency.
"The forex market wasn't expecting such a dovish stance," said Rahul Gupta, head of currency research at Emkay Global Financial Services, who said he now expected the exchange rate to trade between 73.50-74.50 rupees per dollar.
During the RBI's post-policy news conference, Governor Shaktikanta Das said all options were available for it to address exchange rate volatility.
"With regards to forex (intervention), all options are on the table. We will use the various options depending on how the situations unfold," Das said.
The central bank however was absent from the market on Wednesday, which traders said was likely due to the relative outperformance of the rupee in recent months.
They said they expected the RBI to intervene if the rupee's moves were excessive and not in line with fundamentals.
Almost all other Asian currencies gained, tracking U.S. bond yields which continued to retreat, easing pressure on regional assets.
"The RBI policy was actually good overall as there were no negative surprises. But there is a lot of carry trade which got unwound causing the massive fall in the rupee," the head of forex trading at a private bank said.
Some foreign banks had built heavy carry trade positions linked to the bond market.
A government borrowing programme worth over 12 trillion rupees was expected to push bonds yields higher, but the RBI's announcement is expected to temper that rise, causing an unwinding of those positions.
Another trader said oil importer demand and dollar demand from two corporates also weighed on the rupee.