A downgrade will erode India's attractiveness as a global business hotspot and investment destination.
In choppy session, the Bombay Stock Exchange's benchmark Sensex close 72 points down at 20,822.77-the lowest since October 28-as the S&P report triggered heavy selling.
"The negative outlook indicates that we may lower the rating to speculative grade next year if the government that takes office after the general election does not appear capable of reversing India's low economic growth," S&P said in a report released Thursday.
"If we believe that the agenda (of the new government after the 2014 Lok Sabha elections) can restore some of India's lost growth potential, consolidate its fiscal accounts, and permit the conduct of an effective monetary policy, we may revise the outlook to stable. If, however, we see continued policy drift, we may lower the rating within a year," it said.