The BSE Sensex fell nearly 2 percent on Wednesday to close at its lowest in almost a year as blue chips slumped on fears of foreign investor selling after the rupee hit new lows ahead of a U.S. Fed report that may give details of its stimulus policy.
Shares failed to hold on to nearly 2 percent gains seen earlier in the day after the Reserve Bank of India eased cash and bond holding rules for banks on Tuesday.
Analysts said the market was losing confidence in the central bank's policies as its steps to ease cash, bond holding rules on Tuesday deviated from its earlier stance of tightening rupee liquidity.
Foreign institutional investors (FIIs) have turned net sellers of shares in August, looking to extend their selling streak for the third consecutive month.
"First, the central bank needs to clarify its policy direction and second, the FIIs have not been aggressive sellers as yet and that will play out once news over QE tapering unfolds," said Sahil Kapoor, assistant vice-president of retail capital markets at Edelweiss Financial Services.
1.86 percent, or 340.13 points, to end at 17,905.91, marking its lowest close since September 11.
The Nifty fell 1.83 percent, or 98.90 points, to end at 5,302.55 after earlier rising as much as 1.9 percent on the RBI's steps to ease cash and bond holding rules.
Among blue chip stocks, ITC Ltd slumped 4.6 percent while Reliance Industries Ltd fell 5.1 percent.
Shares of IT majors fell on concerns about their valuations relative to the market and on fears that the rupee may regain some of its recent losses as it looks oversold at current levels.
Infosys Ltd fell 1.5 percent while Tata Consultancy Services Ltd ended 1.1 percent lower.
Most bank stocks were not able to hold on to gains made after the central bank eased cash and bond holding rules late on Tuesday.
Book value or net worth of state-owned banks would become more opaque after the Reserve Bank of India eased bond holding rules, Morgan Stanley said in a report on Tuesday.
State Bank of India Ltd fell 0.4 percent after earlier rising as much as 6.2 percent while Canara Bank Ltd ended 4.6 percent lower.
Among private sector banks, ICICI Bank Ltd fell 0.1 percent after earlier rising as much as 6 percent, while Axis Bank Ltd ended 0.3 percent lower after earlier rising almost 9 percent.
However, the NSE bank share index <.NSEBANK> edged up 0.5 percent. Earlier, the index rose as much as 5.93 percent, led by gains among banks whose bulk of lending activities are financed by wholesale deposits.
Yes Bank Ltd gained 5.1 percent while IndusInd Bank Ltd ended 6.4 percent higher.