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Markets recorded their single-largest fall since August 1 after weaker-than-expected business activity in the euro zone and a survey which showed rise in unemployment levels in China raised concerns that global economic growth is still struggling.
Selling by foreign funds also weighed on market sentiment.
The 30-share Sensex ended down 431 points at 26,776 and 50-share NIfty ended down 129 points at 8,018.
Foreign funds were net sellers in equities worth Rs 186 crore on Monday.
In the broader market, the BSE Mid Cap and Small Cap indices ended down 1.9% and 2.9%, respectively.
Asian shares ended mixed on Tuesday as better-than-expected data from China surprised market participants.
Meanwhile, financial markets in Japan were closed for a public holiday on account Autumn Equinox.
The HSBC flash reading on manufacturing for China in September increased to 50.5, from 50.2 in August easing worries of a contraction.
The Shanghai Composite ended up 0.9% and Hang Seng ended 0.5% lower.
Further, Singapore's Straits Times ended flat with positive bias.
However, European shares were trading sharply lower after a private survey showed that business activity in the euro zone comprising of 18 countries in September dropped to a nine-month low at 52.3 in September compared to 52.5 in August, raising concerns that the economy in the continent continues to struggle.
The CAC-40, DAX and FTSE-100 were down 1-1.6% each.
The rupee is trading at 60.91 compared to Monday's close of 60.82 tracking weakness in equities and sale by foreign investors in the previous session.
All sectoral indices on the BSE were in the red with BSE Realty index emerging as the top loser down nearly 5% followed by Metal, Healthcare, Capital Goods, Oil and Gas indices among others.
In the metal pack, Hindalco ended down 2.6% followed by Tata Steel, Coal India and Sesa Sterlite shrugging off the encouraging manufacturing data from China.
The HSBC/Markit Flash China Purchasing Managers' Index rose to 50.5 in September from August's final reading of 50.2.
Auto major Tata Motors witnessed profit taking to end nearly 4% down erasing all the previous session gains even as analysts remain bullish on the stock.
Oil and gas stocks witnessed selling pressure on uncertainty over gas pricing issue. Index heavyweight Reliance Industries ended down 2.7% and ONGC also closed 2.7% lower.
IT exporters witnessed profit taking after weaker than expected housing data which raised worries over growth in the US economy. Infosys and TCS ended down 1-1.1% each.
Bank shares witnessed profit taking after a private poll suggested that the RBI is likely to hold rates at least until the end of the current financial year. ICICI Bank, HDFC Bank, Axis Bank and SBI ended down 0.8-2.5% each.
Mahindra & Mahindra dipped nearly 2% after Credit Suisse downgraded the stock to "neutral" from "outperform" saying the company's valuations are no longer "attractive".
Delhi-based real estate majors DLF and Unitech ended down 6-11% each after the Delhi Government increased the circle rates by upto 20%. Circle rate is the minimum valuation at which properties have to be registered.
Pharma shares were in action today. The government has withdrawn the drug pricing authority's powers that allowed it to fix the prices of medicines not deemed essential. Cipla lost 4% while Sun Pharma ended down 2.2%.
Meanwhile, FMCG majors ITC and HUL along with IT major Wipro were the Sensex gainers.
Among other shares, Sharda Cropchem which made its listing debut today ended 48% higher at Rs 230.60 on the NSE.
Earlier, the shares had listed at Rs 260, a 67% premium against its issue price of Rs 156 per share, on the National Stock Exchange (NSE).
National Buildings Construction Corporation (NBCC) has rallied 4.5% to end at Rs 738 on reports that the foreign broking firm Nomura has initiated coverage on company with a buy for a target price of Rs 1,049 per share.
Shares of Bharti Shipyard gained 3% after the company said its lenders, under the Corporate Debt Restructuring mechanism, have sold the wind mill business.
Shares of IFCI ended up after it said it would sell part of its stake in Tourism Finance Corporation of India Ltd.
Sanofi India surged 11% after the government withdrew National Pharmaceutical Pricing Authority's power that permitted it to fix prices of non-essential drugs.
Market breadth ended negative with 2,146 losers and 876 gainers on the BSE.
