The BSE Sensex slumped 4.1 per cent on Thursday in its biggest one-day slide in more than two years as investors fled risky assets across global markets on a grim US economic outlook and slowing manufacturing growth in China.
A sputtering US economy and headwinds from a European debt crisis could crimp foreign portfolio investments, while a sharp fall in the rupee will accelerate inflation pressures, traders said.
The selloff picked up pace after European stocks tumbled nearly 4 per cent, with export-driven software services exporters such as Infosys, energy major Reliance Industires and banks among the big losers.
"We are mimicking what is happening globally. Our markets will remain weak unless there is some recovery (in Europe)," Sailav Kaji, director of institutional equities at Padmakshi Financial Services, said.
The 30-share BSE index fell 4.13 per cent, or 704 points, to 16,361.15, its lowest close in nearly one month. It was the biggest one-day percentage fall since July 6, 2009 with all of its components dropping.
World stocks as measured by MSCI fell more than 2.4 per cent to a new year low, making for a 14 per cent year-to-date loss.
The more volatile emerging markets stock index was down nearly 5 per cent for a 22 per cent 2011 loss.
The stocks slide sent the rupee skidding to its weakest in more than 26 months and triggered concerns about more pressure on inflation that has been running at more than 9 percent for months.
"We are net importers of crude and rupee-fall will bring in imported-inflation as all our crude imports are in dollar terms," Kaji said.
The Reserve Bank of India had raised rates last week for the 12th time in 18 months and warned fighting stubbornly high inflation remained its priority even as economic growth was slowing.
Shares in Reliance Industries, which has the maximum weight on the main index, fell 6.1 per cent in their biggest one-day fall since June 2009, after media reports the oil ministry may lower the company's cost recovery at its key gas blocks off India's east coast.
A company spokesman declined to comment when contacted by Reuters.
Earlier this month, India's federal auditor had criticised the energy major and the government over development of natural gas field in the Krishna Godavari basin and called for revamping profit sharing arrangements from oil and gas blocks.
Software services bellwether Infosys shed 3.4 per cent and bigger rival Tata Consultancy Services dropped 4.7 per cent.
State Bank of India, the country's largest lender, lost 3.6 percent and rival ICICI Bank fell 4.3 per cent.
Other big losers included realty major DLF, which fell 7.2 per cent, while infrastructure firm Jaiprakash Associates tumbled 9.3 per cent on growth concerns.
The 50-share NSE index closed down 4.08 per cent at 4,923.65 points. There were 10 losers for every gainer in the broader section on heavy volume of 625.4 million shares.
In Europe, where questions about the ability of the euro zone to manage some of its countries' heavy debt remain, stocks losses amounted to a 20 per cent loss for the year-to-date.
The FTSEurofirst 300 fell more than 4 per cent while Japan's Nikkei closed down 2.07 per cent.