The rupee slumped to as low as 66.65 per dollar in the evening session, its lowest since September 2013, as Asian markets reeled under fears of a China-led global economic slowdown.
The local curency hovered in a range of 66.73 and 66.29 in the evening trade.
The rupee has come under huge selling pressure since August 11, when China devalued its yuan currency. The devaluation of the yuan stoked concerns about the state of China's economy, already growing at the slowest pace in 25 years.
The domestic unit had touched its lowest at 68.80 against the American currency on August 28, 2013.
It had lost 29 paise to close at a two-year low of 65.83 against the US dollar on Friday on heavy demand for greenback from banks and importers.
The rupee dropped even as dollar weakened against other major global currencies overseas amid mounting global economic slowdown worries.
A strong dollar demand from importers and banks and heavy losses in the domestic equity market weighed on the local currency, forex dealers said.
Stock market witnessed a bloodbath today with the Sensex crashing by 1,624.51 points or 5.94 per cent to 25,741.56 as steep falls in Chinese equities sparked widespread unrest in global markets.
Even as the rupee breached 66 levels, India is relatively stronger than other countries and the RBI will not have any "hesitation" in using foreign exchange reserves to reduce currency volatility, said the RBI Governor, Raghuram Rajan.
Forex reserves
India has $355 billion reserves and an additional $25 billion of forward sales (due for repayment in future), so effectively $380 billion reserves, Rajan said at a FICCI banking conference.
"While I don't want to opine on future direction of markets, would say relative to other countries, India is in a good position, with strengthening growth, a low current account deficit and narrowing fiscal deficit, moderating inflation, low short-term foreign currency liabilities and very sizeable exchange reserves relative to imports and liabilities," Rajan said.
He added that once market volatility settles down, India should emerge again as an investment destination of choice.
The Reserve Bank does not target a specific level for the rupee, but intervenes in forex markets to curb volatility in the currency through state-run banks.
Macro-economic problems
India's macro-economic problems were "under control",the RBI chief said, adding that the country would need to focus on increasing domestic production as an effective way to protect itself against a global economic slowdown.
Rajan also said the central bank's priority will be to help economic growth by bringing down inflation along a "glide path" that aims to keep consumer prices growing at an annualised rate of between 2 and 6 per cent.
India's annual consumer price inflation slowed down to 3.78 per cent in July, its lowest level on record.