The BSE Sensex fell on Tuesday as blue chips such as HDFC Bank declined on anxiety over potential foreign outflows should the U.S. Federal Reserve signal winding down of its bond-buying programme later this week.
Banks were among the decliners given that an end to U.S. monetary stimulus could push the rupee lower, delaying any rate cuts from the Reserve Bank of India.
Foreign institutional investors have been sellers of Indian shares for five consecutive sessions, totalling 28.95 billion rupees, according to exchange and regulatory data.
"Investors may continue to use rallies to lighten their positions ahead of Fed's decision," said G. Chokkalingam, executive director and chief investment officer at Centrum Wealth Management.
However, the unemployment level in the Unites States is still above 7 percent, so the Fed pulling out in the near future is definitely ruled out, added Chokkalingam.
The benchmark BSE index fell 0.53 percent, or 102.59 points, to 19,223.28, retreating from its highest close in a week on Monday.
The broader NSE index fell 0.62 percent, or 36.45 points, to 5,813.60.
The Federal Reserve is due to end a pivotal two-day meeting on Wednesday. Markets are keenly waiting to see if Chairman Ben Bernanke comments on when and how the Fed will start reducing the third round of its bond-buying programme known as "quantitative easing".
Blue chips fell, with Larsen and Toubro Ltd ending down 1.2 percent, while Oil and Natural Gas Corporation Ltd lost 1.6 percent.
Lenders retreated on worries volatility from a Fed decision to end QE3 could pressure the rupee, delaying any rate cuts after the Reserve Bank of India kept the key lending rate unchanged on Monday.
HDFC Bank Ltd fell 1.5 percent, while Axis Bank Ltd declined 2.2 percent and ICICI Bank Ltd lost 1 percent.
Mahindra & Mahindra Ltd fell 0.6 percent on profit-taking after rising 4.3 percent on Monday, after agreeing to sell a majority stake in its auto component unit to CIE Automotive SA for about $116 million, while also buying a stake in the Spanish auto parts maker.
However, among stocks that gained, telecom shares rose after the new roaming regulations were seen as less stringent than expected and with a negligible financial impact, dealers said.
The Telecom Regulatory Authority of India's (TRAI) said on Monday it would allow carriers to offer free nationwide mobile roaming to subscribers for a fixed fee from July 1.
Reliance Communications Ltd jumped 11.6 percent, while Idea Cellular Ltd rose 1.3 percent.