The Nifty slumped 4 percent on Friday, marking its biggest daily drop in almost two years, as blue chips including HDFC Bank were hit across the board on fears U.S. stimulus tapering would trigger foreign selling and as the rupee hit a record low.
The Reserve Bank of India's measures late on Wednesday to restrict how much its citizens and companies can invest abroad also raised fears of outright capital controls that would further undermine the confidence of foreign investors, hitting the rupee.
The volatility index which measures the cost of protection via options and is seen by some investors as a "fear" gauge gained 26.4 percent, marking its biggest single day percentage gain since June 17, 2009.
The outlook remains weak as Indian shares marked their fourth consecutive weekly fall, totalling a decline of 7.7 percent, as the rupee has tumbled despite various measures undertaken to prop up the currency.
"FIIs (foreign institutional investors) may pull out further on continued concerns over Fed's potential tapering and as the rupee continues to make record lows," said Sachin Shah, a fund manager at Emkay Investment Managers Ltd.
Although valuation has started looking attractive, Shah added.
The Sensex plunged 3.97 percent, or 769.41 points, to end at 18,598.18, also falling 1 percent for the week, marking its fourth consecutive weekly fall.
The Nifty dived 4.08 percent, or 234.45 points, to end at 5,507.85, marking its biggest single daily fall since September 22, 2011.
The index closed below the psychologically important 5,600 level after falling 1.03 percent for the week.
Blue chips fell across the board. HDFC Bank (HDBK.NS) slipped 5.4 percent, while Reliance Industries (RELI.NS) tumbled 4.4 percent.
Axis Bank (AXBK.NS) slumped 8.8 percent after MSCI said it would exclude the bank from its standard and large-cap indexes.
Axis shares also come under pressure after the Reserve Bank of India said on Wednesday overseas investors will not be allowed to purchase additional shares given the foreign shareholding limit has been breached.
Among other stocks consumer goods shares were hit: ITC (ITC.NS) fell 4.3 percent while Hindustan Unilever (HLL.NS) ended 2.9 percent down.
Tata Motors (TAMO.NS) fell 1.6 percent as Wednesday's 9.7 percent gains on unit Jaguar Land Rover July sales were seen as overdone.
Titan Industries (TITN.NS) shares slumped 12.1 percent after the RBI banned imports of gold coins and medallions and required domestic buyers to pay cash for the yellow metal, among other measures.
Analysts said this would increase interest costs and hurt margins for players like Titan.
However among stocks that gained, Financial Technologies (India) (FITE.NS) ended up 2.6 percent after unit National Spot Exchange Ltd on Wednesday said it would settle 55.37 billion rupees worth of outstanding forward contracts over seven months, after earlier suspending trading in these securities.
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