"If the mark to market losses for dollar portfolio increases, foreign investors have to cut back on their losses. That has led to the massive fall in markets," Mr Choksey said.
Foreign investors are increasingly witnessing erosion of wealth as the rupee continues to slide to historic lows virtually every week. With losses mounting because of rupee weakness, they have been forced to book their losses, analysts said. (Read: Sensex sinks 800 points)
Rupee weakness: (Read: Rupee breaches 62, his historic low)
Friday's selloff, however, was triggered by the Reserve Bank's latest move to defend the rupee announced on Wednesday. The RBI restricted how much its citizens and companies can invest abroad to reduce pressure on the rupee. But, traders fear the capital restrictions could adversely impact company profits and could lead to stronger capital restrictions that would scare off foreign investors at a time when the expected tapering of U.S. monetary stimulus is already creating uncertainty in emerging markets.
"When you take kneejerk action, such reaction in stock markets are bound to happen. There measures are too little and too late. When you convey to people that you are running out of currency, global investors start to panic," Mr Choksey said.
The only solution for the RBI is cut rates aggressively now, Mr Choksey said. That will give confidence to markets, he added.
There are fears that an early rollback of U.S. monetary stimulus would trigger a selloff by foreign investors. In the fiscal year that started in April, stocks have attracted a net $2.3 billion in inflows, but if that changes India could find itself with a balance of payments deficit. Debt has seen a net outflow of about $5.7 billion.
Stocks account for a whopping $220 billion of foreign holdings in India, according to Bank of America-Merrill Lynch. Debt makes up a comparatively small $81 billion in foreign assets, government data shows.
End of the bull run?
Shankar Sharma of First Global told NDTV that today's sharp selloff is the beginning of the end of bull market that started in May 2003.
"When a bull market changes into bear market, the first few days' moves are very violent. Such sharp moves could happen incrementally again in the next few weeks," Mr Sharma
Markets are nowhere close to a bottom... this is a good market to short, he added.
Technical analyst Manish Shah told NDTV that if the Nifty closes below 5,470, levels of 4,600 are possible over the next couple of months.
(With inputs from Reuters)