Stock benchmarks fell 1.6% on Monday after dropping almost 1% on Friday and the rupee weakened further, mirroring the selloff overseas, as renewed speculation about a rate increase in the US next week spooked investors, pushing up bond yields and forcing a shift to safe-haven assets such as gold.
Late last week, the European Central Bank's policy inaction had triggered the market selloff.
The Volatility Index (VIX) -a measure of traders' expectations of near-term market risks -jumped 15% on Monday, the highest single-day increase since February 11.
The Sensex fell 443.71 points, or 1.5%, to 28353.54. The Nifty fell 151.10 points, or 1.7%, to 8715.60. Indian markets will be closed on Tuesday on account of Eid.
Extending losses to the third straight day , the rupee on Monday closed at 66.93 to a dollar, down 0.37%, or 25 paise, over its previous close of 66.68. During the day , the currency touched a low of 66.96 but rebounded following the Reserve Bank of India's intervention. Some state-run banks were seen selling dollars at the 66.90 level.
Mid and small-cap stocks, which have outperformed benchmarks in recent months, took a bigger hit on Monday. The BSE Midcap index slumped 3% while the BSE Smallcap fell 2.3%.
In Europe, bond yields rose on Monday with 10-year benchmarks of Portugal, Spain and Italy advancing to near-two-month highs. Bond yields and prices move in opposite direction.
After ECB, a chorus of comments from US Fed officials has raised fears of rate-tightening. On Friday, US Federal Reserve Bank of Boston president Eric Rosengren said the American economy could overheat should policy-makers wait too long to tighten.The market will watch Fed Governor Lael Brainard's remarks on Monday for further hints on interest rate direction.
Investors are worried that foreign funds would be tempted to pull money out of emerging markets at this juncture as many feel the market has run up too fast, too soon.
Foreign portfolio investors (FPIs) sold shares worth Rs.590 crore on Monday. They had offloaded stocks worth Rs.337 crore on Friday. From the start of September till Thursday, FPIs had pumped Rs.1,900 crore into Indian stocks.
Overseas fund managers said India will track any weakness in global markets, but remain bullish about its prospects.
Gold held steady while oil prices fell for the second straight day on Monday following increasing oil drilling activity in the US.