Investor confidence was further dented when European shares initiallyextended a two-week slide after a euro zone plan to boost crisis funds parked with the IMF failed to reach a hoped-for target.
Engineering and construction conglomerate Larsen and Toubro, which has been facing a slowdown in new orders as companies put off investment in large projects, was among the big losers.
"The whole India story was built around just one word -- growth," said Jagannadham Thunuguntla, research head at SMC Global Securities.
"Now that growth is not there and nobody is interested in this market."
The main 30-share BSE index shed 1.33%, or 204.26 points, to 15,175.08, its lowest close since August, 2009.
All but 5 of its components ended in the red.
Industrial output in India fell for the first time in two years in October, shrinking 5.1%, and the central bank held interest rates unchanged last week after 13 rounds of increases since early 2010.
Pushed to a corner by a series of corruption scandals, the ruling coalition has been unable to reach a consensus on policy decisions that are needed to lift investment and growth.
Foreign funds have pulled out a net $300 million from Indian shares this year till last Friday, after ploughing in a record of more than $29 billion in 2010.
"It is tough to find many optimists willing to bet their money on Indian equities at the moment," brokerage IIFL said in a research note on Tuesday.
Swelling fiscal deficit, widening current account gap, high interest rates, slowing economy and policy inaction were driving investors away, it said.
The benchmark BSE index has lost 5.2% over five sessions, taking the fall to 26% since the start of January and making it the worst performing major stock market in the world.
Larsen & Toubro fell 5.3% to 977.70 rupees, its lowest close since May, 2009.
Energy major Reliance Industries, which has about 10% weight on the main index, fell 3% and Bharti Airtel, the country's largest mobile operator, shed 3.9%.
Production cuts announced by European steelmakers this month because of gloomy outlook for steel demand weighed on metal makers.
Tata Steel, the world's seventh biggest steelmaker, dropped 5.7%, while Jindal Steel and Power fell 3.8%.
Media firm Network 18 bucked the trend and rose 6.9% after a newspaper report Mukesh Ambani, India's richest man and head of oil and gas major Reliance Industries , is seeking to buy a stake in the company.
A Reliance spokesman said the company was not interested in buying a stake in Network 18.
The 50-share NSE index fell 1.5% to 4,544.20.
There were about 2.8 losers for every gainer in the broader market. About 573 million shares changed hands.
At 1030 GMT, the FTSEurofirst 300 index of top European shares was up 0.4%. World stocks, as measured by the MSCI world equity index, rose 0.3%.