The stock market barometer BSE Sensex, which was trading weak in the morning trade, crashed over 559 points or 2.7 per cent to 20,087.44 soon after the mid-quarter policy by RBI.
RBI Governor Raghuram Rajan in his maiden policy review, however, eased liquidity though the reduction in rate at which banks borrow by 0.75 per cent was lower than the expectation.
The repo rate or the short term lending rate has been increased by 25 basis points to 7.5 per cent from 7.25 per cent with immediate effect.
The NSE Nifty fell 2.48 per cent or 152 points to 5,963.65.
The forex market also reacted negatively and the rupee depreciated 69 paise to 62.46 to a US dollar.
The markets had soared to a three-year high yesterday after the US Federal Reserve unexpectedly left its stimulus programme unchanged, easing fears of capital outflows.
Notwithstanding market expectation of status quo policy from Rajan, the RBI today delivered a hawkish policy with focus on anchoring inflationary expectation.
"Inflation remains the top priority of RBI and will remain the case. Rate hike came absolutely in a surprise form to the market. It is a matter of time that most of the gains which were build up by the market in the last 15 days will be back," Chief Strategist at SMC Global Securities Jagannadham Thunuguntla said.
BSE Sensex down on profit-taking after 3-day rally ahead of Raghuram Rajan-led RBI meet
BSE Sensex falls on profit-taking after a three-day rally and on caution ahead of the central bank's policy review later in the day. The benchmark index falls 0.3 percent, while the edges down 0.2 percent.
Among blue chip shares, falls 1 percent while Larsen & Toubro (L&T) is down 2.8 percent.
However, foreign investors bought cash shares worth 35.43 billion rupees and derivatives worth 31.17 billion rupees on Thursday, exchange data shows, after the U.S. Federal Reserve's decision to keep its stimulus intact.
Foreign institutional investors (FIIs) have bought 113.5 billion rupees ($1.83 billion) worth of Indian shares over the previous 11 sessions, exchange and regulatory data shows.