"The market is extremely nervous. Everyone had thought that Moody's would downgrade us by one notch, but they have gone and downgraded us by two notches. Exporters have already decided to hold on to dollars after the new downgrades," said a treasurer in a private sector bank.

Dealers said that the rupee will open weaker and unless the RBI intervenes, the currency might test new lows. The RBI top brass, who were away in Srinagar to attend a board meeting of the bank when the Moody's downgrade happened, returned to Mumbai on Saturday and immediately took stock of the situation.

"The entire week will be very volatile. There will be buying by nervous importersand exporters are likely to hold on as they know that the rupee will weaken further. This will create demand-supply problems and in a thin market like this, it will create panic. The RBI should try and calm the nervousness of the market," said a dealer in a foreign bank. Dealers also added that any further selling and repatriation of forex by foreign institutional investors (FIIs) would exacerbate the pressure on the rupee.

Forward premiums are likely to increase and the six-month annualised premium is expected to touch 12 per cent. It closed at 10.4 per cent last Friday. A rise in forward cover rates is likely to put pressure on the money market, which is already tightening after the Rs 5,000 crore outgo on the purchase of "on tap" government securities.

The State Bank of India, which has been selling dollars in the forex market over the last few weeks, is likely to continue to do so, some dealers feel. "If the SBI intervenes, it will be on behalf of the RBI," a senior dealer in a public sector banksaid.

Sources in the foreign exchange market said the RBI is looking at a band of 41.90-42.10 against the dollar and is prepared to defend the Indian currency against speculative attacks. In fact, finance secretary Montek Singh Ahluwalia has gone on record as saying that the rupee should be stable at 42. Commerce minister Ramakrishna Hegde has also put forth a similar view on the rupee. On Friday, the rupee closed at 42.17/22 after firming up to 41.85 on Thursday. The Indian unit plunged to a historic low of 42.42/45 on June 10 after the State Bank of India withdrew from the market.

Analysts said that the current level of the rupee is undervalued if one takes the imputed value of the currency based on the real effective exchange rate (REER). If one considers the base year as 1996-97, the rupee based on the REER should be around 40.66 to the dollar. The current value of the rupee is 42.17. t should, therefore, strengthen, a senior treasurer said.