The Economic Times reported the drop was the largest one-day decline by percentage in more than a decade.
The Sensex fell to 17,968.08, losing 590.05 points. The Nifty index on the National Stock Exchange, a listing of 50 stocks, dropped 3.5 percent to 5,284.60 points.
The rupee closed at 66.24.
With the weakening rupee, foreign investors have pulled back, withdrawing about $810 million from Indian investments over the past seven trading sessions.
The latest deterioration in the currency came with the passage of the Food Security Bill, which is raising government debt.
"The government can afford a vast new food program for the poor despite its impact on the strained public finances," Finance Minister P. Chidambaram said. But the attempt to salve investor worries did not appear to have a mitigating effect.
"With current weakness in rupee, even Reserve Bank of India does not have much headroom to control the Indian currency. We have seen indicators related to fiscal balance sink," G Chokkalingam, the managing director and chief investment officer at Centrum Wealth Management, told the Times.
Analysts are also pointing to rising tension in Syria and rising prices for crude oil as factors undermining Indian markets, the Times said.
"Given the fact that now we are really in the last week of the month, the oil import demand is also playing a role as far as the rupee is concerned," said Aditi Navar, an economist with Indian credit rating agency ICRA.
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