Fears Spain will have to seek a full sovereign bailout, coupled with mounting worries that Greece may leave the euro, sent the euro sliding to a two-year low against the dollar and a near 12-year trough against the yen on Monday.
Some doubts about whether the government can deliver on policy reforms after presidential elections last week also appeared to dent investor confidence, contributing to a steep 1.6 percent drop in the main BSE stock index.
Media reports that government coalition members Samajwadi Party and leftist parties are opposed to opening up foreign investments into multi-brand retail outlets sparked a sell-off in retailers.
"The market is basically tracking the euro story. However, 56 should cap the current bout of rupee weakness. Going forward, RBI will intervene if it goes out of hand," said Satyajit Kanjilal, chief executive at Forexserve, a forex risk advisory firm.
The partially convertible rupee closed at 55.9650/9750 per dollar, as per the SBI closing rate , weaker than its close of 55.32/33 on Friday.
It fell 1.2 percent during the session, its biggest fall since June 22.
A bigger loss for the rupee was capped after a private petrochemical company was spotted heavily selling dollars in the session, several dealers said.
The rupee could face strong technical support at 56.11, the 61.8 percent Fibonacci retracement of the rupee's gains from a record low of 57.32 on June 22 to the monthly high of 54.18 hit July 4.
Beyond the euro, a lack of policy reforms could most hinder the rupee, given a large part of the rupee's recovery since it hit its life low of 57.32 on June 22 has been driven by hopes the government would tackle action to reduce its fiscal deficit and attract foreign investment. The one-month offshore non-deliverable forward contracts were around 56.39 while the three-month was at 57.05. In the currency futures market, the most-traded near-month dollar-rupee contracts on the National Stock Exchange, the MCX-SX and United Stock Exchange all closed at around 56.05 with the total traded volume at around $5.5 billion.