Sensex fell for the eighth time in nine session, shedding 2% on Monday to their lowest close in more than four months, on concern the government may review a tax treaty with Mauritius, leading to worries foreign inflows could be hit.
Market participants said talk of the treaty review further hurt sentiment in the market that was already jittery due to stubborn inflation and slowing growth.
A chunk of foreign investment in the stock market comes through companies registered in the Indian Ocean island.
The tax treaty provides that capital gains arising in India for these companies from the sale of securities can only be taxed in Mauritius. The island nation does not tax capital gains, leading to zero taxation for the firms.
The two countries are expected to review the treaty soon, a source in the finance ministry said, but declined to elaborate on the time-frame.
Following a series of corruption scandals in high places the government has come under intense pressure to plug loopholes from tax-havens.
"The market is hammered on worries the tax treaty with Mauritius could be reviewed," said Ambareesh Baliga, chief operating office of Way2Wealth Securities.
He said it would be difficult for the market to recover from these levels due to the weak sentiment and expects further downside.
The 30-share BSE index fell 2.04%, or 363.90 points, to 17,506.63 points -- its lowest close since Feb 10. Twenty seven of its components lost ground.
However, some traders downplayed the worries over the Mauritius tax treaty.
"I think it will take at least nine to 12 months to finalise the treaty if at all it happens," Samir Arora, fund manager at Singapore-based Helios Capital Management.
Foreign funds were sellers of Indian shares all of last week, and offloaded about $330 million of stocks.
Overseas funds hold more than $100 billion of Indian shares, accumulated since India opened the door to foreign institutional investors in 1992, data from the Securities and Exchange Board of India showed.
Network engineering services provider GTL nosedived as much as 63.3% to 124.15 rupees, its lowest level since December 2006, while group firm GTL Infra slumped as much as 48.5% to a life-time low of 15.25 rupees.
The stocks pared some losses and closed 62.2% and 42.7% lower, respectively.
Dealers said GTL may have either fallen behind in debt repayment or a stake-holder could have sold shares in the open market.
Company chairman Manoj Tirodkar told CNBC-TV18 he believes the company was regular in its payments and the fundamentals of business remained strong.
GTL Infra and GTL were the most traded stocks on NSE, with volumes of 114.7 million
shares and 51.2 million shares respectively
Mobile operator Reliance Communications and utility Reliance Infrastructure, controlled by billionaire Anil Ambani, tumbled 7.9 and 6.2%, respectively, after the Bombay Stock Exchange said they would be removed from the main index from Aug 8.
Software firms led the decline, after CLSA downgraded the Indian IT sector to "underweight" from "neutral," saying their quarterly revenue growth on an annual basis has peaked and a downtrend was likely.
It downgraded Tata Consultancy Services and Infosys to "underperform," sending their stocks down 3.6% and 2.2%, respectively.
Nearly eight shares declined for every share that advanced on NSE, on a volume of 788 million shares, higher than the 90-day daily average volume of 600 million shares
The 50-share NSE index was down 2% at 5,257.95.
World stocks measured by the MSCI All-Country World Index fell 0.5% at 1018 GMT, while the emerging market equities dropped 0.6%.