The Nifty posted its biggest percentage fall in a year on Thursday, as the prospect of an end to the U.S. stimulus programme and a weak China manufacturing survey sparked concerns foreign investors would end their recent buying spree.
The biggest concerns focused on Federal Reserve Chairman Bernanke's comments suggesting bond purchases could be scaled back if the U.S. economy improves, with falls magnified after State Bank of India slumped after disappointing quarterly earnings.
A potential early wind-down of the U.S. stimulus programme could hit Indian stocks badly, analysts have warned, as foreign institutional investors have been net buyers for 25 consecutive sessions, helping spark a rally since mid-April.
Still, analysts said prospects of the Reserve Bank of India cutting interest rates again in June after easing three times this year could help support shares.
"Indian markets were overbought and therefore we are seeing some correction. Some outflows are possible but it will be not be an exodus," said Paras Adenwala, MD & Principal Portfolio Manager, Capital Portfolio Advisors.
The Nifty fell 2.09 percent or 127.45 points, to end at 5,967.05, marking its biggest daily percentage fall since May 8, 2012.
The Sensex fell 1.93 percent or 387.91 points, to end at 19,674.33, falling for a fourth consecutive session.
The NSE's volatility index, considered by some investors as a fear gauge, jumped as much as 8 percent to its highest level in eight months on worries about outflows even as Finance Minister P. Chidambaram said fears U.S. monetary stimulus programme reversal were unfounded.
A weak manufacturing survey from China added to concerns about a delayed recovery in the world's second-largest economy, contributing to steep share losses throughout Asia.
State Bank of India slumped 7.9 percent after posting its first quarterly net profit drop in two years and missing market estimates because of lower interest income and higher provisions for loan losses.
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However, among stocks that gained, Oracle Financial Services Software Ltd