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Prime Minister Manmohan Singh said inflation poses a "serious threat" to the nation?s growth momentum.
Investors have also been concerned over the impact Egyptian crisis of the past few days may have on Indian firms with presence there, amid apprehensions that the political turmoil may spread across the region.
The Bombay Stock Exchange benchmark Sensex, which had gained 427 points in the last two trading sessions, turned volatile and plunged 441.16 points to 18,008.15, a level last seen on August 31.
The gauge had dipped below 18,000 level in the last 30-minute trading after initially rising to 18,542.20. The benchmark, the world?s worst performer so far this year, has dropped 13 per cent from November 5 record levels.
In a similar fashion, the broad-based National Stock Exchange index dipped below 5,400 points level by losing 131 points to settle at 5,395.75. It touched the day`s high of 5,556.30 as market remained volatile.
The trading sentiment remained jittery over the interest rate hike as Singh said at a high-level meeting that inflation posed "a serious threat to the growth momentum".
Brokers were of the opinion that the current hefty fall was mostly attributed to the rising inflation and interest rates, besides mounting tension in Egypt.
They said foreign investors were refraining from enlarging their positions and taking out their funds from emerging markets on geopolitical tension also dampened the market sentiment.
The two most-heaviest counters with their 23 per cent weightage on Sensex - Reliance Industries and Infosys Technologies declined to led the fall. RIL dropped by Rs 24 to Rs 919.50 and Infosys by Rs 69.50 to Rs 3,046.35.
The realty sector index suffered the most by losing 3.37 per cent to 2,199.24 followed by FMCG index by 3.08 per cent to 3,214.30. Teck index lost 2.28 per cent to 3,689.99 and IT index by 2.26 per cent to 6,258.50.
