The rupee hit a one-month low of 59.67 on Friday as mounting tensions in Iraq sent Brent prices to 9-month low. The partially convertible currency is now at its lowest since May 15 and below Thursday's close of 59.25 per dollar.
India imports nearly 75 per cent of its crude and rising oil prices will create additional demand for dollars, putting pressure on the rupee. State-run retailers such as BPCL, HPCL and Indian Oil Corp are the biggest source of dollar demand in markets - worth $400 million to $500 million daily.
Last year, RBI Governor Raghuram Rajan had opened a swap window to provide dollars directly to state oil companies in its attempt to shore up the rupee.
Indian stock markets also fell sharply in line with the currency. The Sensex fell over 400 points while Nifty declined below the psychological important 7,550 mark.
Shares in oil marketing companies fell sharply with BPCL falling nearly 6 per cent. The stock was the top Nifty loser. Other oil retailers such as Indian Oil and HPCL also traded with over 7-8 per cent cuts.
Rising oil prices adversely impact the profitability of state-run retailers who sell diesel, kerosene and LPG at subsidised rates. Only petrol is sold at market rates in India.
"There have been no disruptions to oil supplies so far but people are very nervous," said Ken Hasegawa, a Tokyo-based commodity sales manager at Newedge Japan, referring to worries that escalating violence in Iraq could disrupt oil supplies from the second-largest OPEC producer.
"Oil is now in a new price territory and is likely to climb more as investors rework their positions, supported by the uncertainty and technicals."
(With inputs from Reuters)