The rupee fell below the 62 level for the first time, plummeting to 62.03 against the dollar, after the Reserve Bank of India announced additional steps on Wednesday to restrict foreign-exchange outflows and gold imports.
The markets were also spooked by expectations that an improving US economy would lead to a flight of foreign capital from the domestic markets.
"The fear (among foreign investors) is that recent RBI measures may bring capital control measures back in a much bigger way. The markets crashed chiefly because of this," said Gautam Sinha Roy, VP-Equities, Motilal Oswal Securities.
The stock markets were jolted by weakness in global stocks after a steep fall on Wall Street yesterday as jobless claims declined to the lowest level since 2007, renewing concerns that the US Federal Reserve would start withdrawing its stimulus from as early as next month.
The 30-share Sensex opened lower at 19,297.11 from the previous close of 19,367.59. It dropped to a low of 18,559.65 and closed at 18598.18, a 769.41 point drop, or 3.97%.
This was the largest point-wise fall since July 6, 2009, when the index plunged by 869.65 points. Investors were over Rs. 2 lakh crore poorer as 6 out of 10 stocks fell on the BSE.
To curb dollar outflows, the RBI on August 14 announced stern measures, including curbs on Indian firms investing abroad and on outward remittances by resident Indians.
The other losers included PSU index which went down 259.22 points, automobile index which dropped 256.85 points, FMCG slid 254.29 points and FMCG index plunged 179.39 points.
Stocks of banks, consumer durables, oil and gas, capital goods, metal, automobile, public sector undertakings (PSU) and fast moving consumer goods (FMCG) saw heavy selling.
The huge selling pressure in the stock markets was created by the high demand for the US currency.
Recent industrial and employment data from the US and some major European economies like France and Germany has shown significant improvement, making these markets more attractive than India.
The creation of more jobs in the US may translate into an early end to the US stimulus programme, which earlier led the US Federal Reserve to end its bond-buying programme.
Brokers said trading sentiment dampened on increased selling by foreign funds as rupee fell to record low of 62 per dollar raising fears of slowing economic growth.
They said a weak trend in Asian and European stock markets on speculations that the US Federal Reserve might roll back monetary stimulus further influenced the market.
Today major losers were Reliance Industries, BHEL, Maruti, HDFC, Sterlite Industries and ICICI Bank.
Rupee at new all-time low
Rupee plunged to a new record low against the dollar Friday and stocks slid 2.66% over fears that foreign capital could flow back to the United States as the American economy improves.
The rupee, one of Asia's worst-performing currencies this year, hit a new low of 62.03 rupees to the greenback, slipping past its previous low of 61.80 rupees on August 6.
The drop in value reflects fears that recent measures by the central bank may not be able to help the ailing currency, dealers said.
The government slapped new controls on foreign exchange outflows Wednesday to try to arrest the rupee's fall.
Dealers said there was no immediate sign of an intervention by the central bank to prop up the rupee, which at Friday's low had depreciated 13.2% compared to its value against the dollar in 2013.
The rupee's woes come as the government is struggling to turn around India's once red-hot economy by pledging new steps to narrow the gaping current account deficit -- the broadest measure of trade.
The economy grew at a decade-low 5.0 percent in the year to March.
The depreciating rupee stokes inflation by raising the cost of everything India imports from crude oil to chemicals and pulses.
RBI not considering any measures
The RBI is not considering any capital control measures, it was clarified on Friday as the central bank's recent capital outflow measures spooked the stock markets.
Top sources in RBI blamed "unwarranted rumours" about controls on FII money to the nearly 770 point drop in the benchmark Sensex and rupee dipping to its lowest levels.
No capital control measures were being considered, the sources insisted.
India, they said, had no record of keeping controls on FII money and the capital outlow measures announced on Wednesday were no way bringing back the control regime.
The move to cut the amount companies can invest overseas without seeking approval to 100% of their networth from 400% does not mean firms cannot invest the previously stated limits, sources said.
'Rupee volatility impacting stock markets'
The finance ministry on Friday said excessive rupee volatility is impacting the equity markets.
"Our sense is that what is seen in India is happening due to what is happening all over the world. The rupee worry also spills over to the equity markets and the equity worry spills over to the rupee. It is potentially vicious," a ministry official said.
"The rupee will finally find a level based on the state of the economy...We are happy or prepared to live with orderly movement in the value of the rupee," he said, adding that the government and the RBI at present do not want to use their armoury and would rather stick to relatively smaller measures that won't choke growth.
"If the government wants to arrest the fall in the rupee by completely choking liquidity, it is very easy to arrest the fall in the rupee, thereby hurting the growth process," he said.
The decline in the currency and the equities markets, he said, was also on account of US data showing that joblessness in America was reducing, fuelling fears that the Federal Reserve would start withdrawing its stimulus.
US Federal Reserve Chairman Ben Bernanke had earlier indicated that the Fed could taper its bond-buying programme with an improvement in the US economy.
"The data which has come out indicates this could finally be the beginning of easing. It (the tapering) could be as early as next month's bond-buying programme," the official said, adding that this concern affected the markets today.
To restrict the outflow of foreign currency, the RBI had on August 14 announced stern measures, including curbs on Indian firms investing abroad and on outward remittances by resident Indians.
The finance ministry official, however, said the measures taken by the RBI cannot be called capital control measures and they had more to do with reducing stress on the balance sheets of corporates.
"With rising NPAs, corporates are getting more and more into difficulties...so looking into their balance sheet before they are allowed to invest abroad is all that has been proposed. Hence, it is not capital control," the official added.
He said if the government is taking measures to increase capital inflows, it is part of the package to take measures to discourage outflows.
Earlier this week, finance minister P Chidambaram had reiterated that the current account deficit (CAD) would brought down to USD 70 billion this fiscal from USD 88.2 billion in the previous year and steps would be taken to increase foreign fund inflows.
Referring to the rupee, he had said: "Given our fiscal deficit, given our CAD, there will be some pressure on rupee and rupee will indeed depreciate. All that we are saying is that we cannot allow the rupee to go into a free fall. We are arguing for a stable rupee."
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