The decline was limited by a sluggish dollar overseas and sustained capital inflows, a forex dealer said.
Indian rupee opened higher at 61.90 a dollar from the previous close of 62.07 and logged a high of 61.76 as local stocks made initial gains.
The Indian rupee then dropped, in line with stocks, to a low of 62.52 before ending at 62.51, a fall of 44 paise or 0.71 per cent. In the previous two days, it had risen by 68 paise to a one-week high.
"Indian rupee started weakening due to dollar buying by banks and corporates. Month-end buying of dollars and short covering was seen putting pressure on the rupee," said Abhishek Goenka, CEO of India Forex Advisors.
Finance Minister P Chidambaram today said the right level for the Indian rupee is 59-60 to a dollar, as per the real effective exchange rate, and it shouldn't overshoot that level.
Chidambaram also said the Finance Ministry supports the idea of treating bank credit to exporters as priority sector lending and is talking to the Reserve Bank about it.
The 30-share S&P BSE Sensex declined 166.58 points or 0.84 per cent. Foreign institutional investors bought a net Rs 172.15 crore of shares yesterday, according to provisional data with the stock exchanges.
The dollar index, a gauge of six major global rivals, was down by 0.20 per cent.
"The trading range for the US dollar, Indian rupee pair for the week is expected to be within 61.50 to 62.80," said Pramit Brahmbhatt, CEO of Alpari Financial Services (India).
RBI Governor Raghuram Rajan said in Frankfurt that there is still some inflation in India, even after stripping out the effects of food and energy.
Asked about the RBI's policy stance, Raghuram Rajan said, "At this point we are neutral, we will see how things develop."
"On Monday, India's CAD for the June quarter will be released, which will be an important piece of data," said Goenka of India Forex Advisors.
Forward dollar premiums eased further on sustained receipts by exporters.
The benchmark six-month forward dollar premium payable in February declined to 233-237 paise from Thursday's close of 236-239 paise and far-forward contracts maturing in August ended a tad lower at 453-456 paise from 453-458 paise.
The RBI fixed the reference rate for the dollar at 61.8110 and for the euro at 83.4200.
The Indian rupee fell to 100.61 against the pound from 99.62 previously and dipped to 84.48 per euro from 83.79. It dropped against the Japanese yen to 63.46 per 100 yen from 62.89.