Shares fell for the first session in four as banks and real estate developers reversed recent gains after a services index dropped while input costs rose, sparking fears of a worrisome combination of slowing growth and high inflation.
The caution also reflected weaker global stock markets after Spanish borrowing costs jumped at a bond auction, which came a day after US equities were already hit when the Federal Reserve appeared less inclined to provide more stimulus.
The falls on Wednesday snapped a three-day winning session that sent India's main two indexes up over 3% each during that period, with investors further cautious ahead of a two-day holiday. Markets will resume on Monday.
"There is absolutely no doubt that economy is slowing down as also depicted by the services data today," Paras Adenwala, Principal Portfolio Manager at Capital Portfolio Advisors.
"RBI will have to do something, rate cut or CRR cut on April 17 to stimulate growth without fanning inflation," he added, referring to the cash reserve ratio. Although many analysts expect a rate cut this month, doubts are emerging about how aggressive the central bank will be in the months ahead.
The HSBC Markit Business Activity index fell to a five-month low of 52.3 in March as optimism about the business outlook faded. However, the same indicator showed input prices charged to consumers inched up, suggesting inflation could remain high.
"With high inflation curtailing growth and the inflation outlook still not particularly encouraging, the RBI would, in our view, have to approach the easing cycle very cautiously, if not hesitantly," said HSBC in a note about the index results.
The 30-share main index fell 0.63% to 17,486.02 with 23 of its components in the red zone.
The broader Nifty fell 0.66% to 5,322.90.
Banks were among the leading decliners on Wednesday after a sub-index gained 5.1% over the previous three sessions to lead advances in the broader indexes.
ICICI Bank, India's second-biggest lender, fell 1.98%.
Real estate stocks also reversed recent gains, ending down on fears a less aggressive central bank would further hit a sector with struggling earnings. DLF Ltd, India's largest listed developer, fell 1.47%.
Among other decliners, GAIL India lost 3.2 % after an Indian regulatory body said it would cut tariffs for parts of GAIL's liquefied petroleum gas (LPG) network, sparking fears about profit margins at the state-run gas distributor.
But among gainers, Maruti Suzuki rose 0.47% after Morgan Stanley upgraded the stock to "overweight" and raised its target price on the stock, saying India's top car maker's earnings would recover in the year ending March 2013.