Mumbai: Indian stock markets closed at a 25-month low on Friday as foreign investors sold local shares and short positions rose in the derivatives market after the Reserve Bank of India (RBI) in its monetary policy admitted that downside risks to growth have increased, but stopped short of announcing rate cuts.

The benchmark Sensex fell 345.1 points, or 2.2%, to close at 15,491.35 points.

Redemptions from India-focused funds owing to macro-economic concerns led to the fall and markets could drop a further 4-5% in the coming weeks before bottoming out, analysts say.

“The markets have fallen today because the foreign investors are pulling out money from India due to redemption pressures," said Saurabh Mukherjea, head of equities at Ambit Capital Pvt. Ltd. “RBI did not give an explicit guidance on when they will start cutting rates, which has also weighed on the markets."

Sensex at closing

Foreign institutional investors (FIIs) sold shares worth 220.25 crore on Friday, according to provisional data of the National Stock Exchange (NSE).

After pumping in a record $29 billion in 2010, FIIs have largely shied away from Indian stocks in 2011, pulling out $310 million so far this year.

Persistently high inflation, rising interest rates, a burgeoning fiscal deficit, a deteriorating current account deficit, a weak rupee and slowing investments and gross domestic product (GDP) growth have taken a heavy toll on the Indian markets this year. The Sensex has fallen 36% in dollar terms so far this year, making India the worst-performing market in Asia.

India’s GDP growth fell to a two-year low of 6.9% in the quarter ended 30 September and factory output growth turned negative for the first time in two years in October, owing to a sharp contraction in the capital goods sector.

“Fundamentally, the economy is in a weak spot and I do not see any serious buyer in the market," said Sandeep Singal, co-head, institutional equities, Emkay Global Financial Services Ltd. “We expect the Sensex to trade in the 14,500-16,500 range".

Banking stocks, considered a barometer of the economy, were among the worst performers on Friday. The nation’s largest lender, State Bank of India, declined 3.67%, while the largest private lender, ICICI Bank Ltd, fell 3.18%. Capital goods shares were the worst hit on concerns of projects getting deferred and a slowdown in capital investments, with the capital goods index of BSE falling 4.4% on Friday. Capital goods bellwether Larsen and Tourbo Ltd was the top loser on the Sensex, falling 5.3%.

“There has been a build-up of short positions over the week and it is possible for the markets to fall 4-5% more," said Sandip Sabharwal, head of portfolio management services at Prabhudas Lilladher Pvt. Ltd.

The markets could bottom out at those levels if the global outlook improves, as markets have largely priced in domestic negatives, Sabharwal said.

Positive global cues such as a resolution to the European sovereign debt crisis and a revival in global growth as well as a push to the domestic reforms process by the government may act as triggers for a market rally, analysts say. “With monetary policy seen as restrictive, cash levels (of global fund managers) high, and almost one in two (fund mangers) expecting a euro break-up, investors end 2011 in a grim, resigned mood, leaving the consensus more vulnerable to good news rather than bad news in the New Year," wrote Michael Hartnett, global equity strategist, Bank of America Merrill Lynch, in a Tuesday report on asset allocations of global fund managers.