The BSE Sensex ended lower on Wednesday, led by profit-taking in banking stocks, after rating agency Standard & Poor's warned the country still faces a threat of a rating cut despite recent reforms.
S&P said the recent reform steps initiated by the government had helped in "slightly" revising its view on the country's credit rating, but warned India still faced a one-in-three chance of a credit rating downgrade within the next 24 months.
European shares fell for the third day running as economic anxiety was compounded by stuttering progress in the euro zone's battle against its debt crisis.
Dealers are looking forward to October quarter earnings that begin later this week when information technology company Infosys and private sector bank HDFC Bank report their second-quarter results. Investors and analysts will closely watch the management commentary for further action.
"This earnings (season) will be the last quarter with subdued earnings. Come next quarter, all the decisions taken by the government will be reflected," said Jagannadham Thunuguntla, head of research at SMC Investments and Advisors Ltd.
"Lot of positive (effects) will start showing form the next quarter. Hopefully, if there is an interest rate cut by the RBI, that will show up as well and strengthening of the rupee will also get reflected."
The Sensex fell 0.86 percent, or 162.26 points, to end at 18,631.10 points.
The 50-share Nifty lost 0.92 percent, or 52.45 points, to end at 5,652.15 points, closing below the psychologically important 5,700 level.
However, if the Nifty goes below the 5,650 level, the near-term trend may turn to be bearish, and further selling pressure may be seen. Industrial data on Friday and Monday's inflation data will impact the near-term market trend.
Inflation probably accelerated to its highest level this year in September because of costlier fuel after the government cut subsidies, according to a Reuters poll, complicating the task of the Reserve Bank of India as it faces pressure to ease monetary policy to revive growth.
ICICI Bank ended 0.9 percent lower, while HDFC Bank fell 1.25 percent and State Bank of India closed 2.6 percent lower.
India's car sales are seen growing just 1 percent to 3 percent in the current financial year, an industry body said, slashing its previous estimates as high interest rates and slowing economic growth continue to stifle a once-booming industry.
Mahindra & Mahindra fell 2 percent, Maruti Suzuki lost 1 percent.
Shares in Jaiprakash Associates ended up 2.5 percent. The company has renewed talks with Aditya Birla-controlled UltraTech Cement and Switzerland's Holcim Ltd to sell its cement plant in Gujarat to pare its debt, a source with direct knowledge of the matter said.
Irish building materials group CRH Plc said on Tuesday it has ended talks with Jaiprakash, the cement-to-power conglomerate, to buy an equity stake in the plant.
Blue-chip capital goods stocks were also hit by profit-taking. Larsen & Toubro closed 1 percent lower, while BHEL lost 2.04 percent.
Telecom shares extended fall over airwave surcharge concerns. Bharti Airtel fell 1.23 percent, while IDEA declined 2.6 percent.