Besides, winding up of positions by participants on the last session of February's expiry in the derivatives segment, hit the trading sentiments, brokers said.
Stocks of cement, coal and steel companies suffered losses following hike in railway freight rates by up to 10 percent.
With Railway Minister Suresh Prabhu sparing passengers from any hike in fares, market was abuzz with speculation that the Union Budget to be presented on Saturday will have a populist tilt, brokers added.
The 30-share BSE Sensex after a better start, rose further to touch the day's high of 29,069.13 in early trade. However, it slipped into the red as selling pressure gathered momentum after the railway budget. It dipped below the 29,000-mark to hit a low of 28,693.82 before settling 261.34 points, or 0.90 percent, down at 28,746.65.
Today's drop is the biggest daily fall for the Sensex since the 490.52-point crash on February 9.
On similar lines, the NSE index Nifty slipped below the crucial 8,700-level by falling 83.40 points, or 0.95 percent to close at 8,683.85. Intra-day, it shuttled between 8,669.45 and 8,786.05.
Shares of companies related to the railway sector came under pressure. While measures proposed in the Rail Budget such as reviewing the wagon-making scheme aim to make it attractive for private investors, profit-booking set in.
Major losers were Texmaco Rail (-2.51 percent), Kalindee Rail Nirman (-4.05 percent), Stone India (-7.01 percent), Simplex Castings (-4.26 percent) and BEML (-1.65 percent).
Stocks of cement firms such as ACC, Ultratech and Ambuja cement slipped following freight hike announcement.
Among the 30-Sensex constituents, 24 ended lower, five closed higher, while Hero MotoCorp closed unchanged.
Meanwhile, foreigners bought shares worth Rs 516.06 crore yesterday, and domestic institutional investors bought shares worth a net Rs 19.60 crore yesterday, as per provisional data.
Globally, other Asian markets closed higher and European indices climbed in their opening trade.
Among sectoral indices, Auto, IT, Capital Goods, Healthcare, FMCG, Metal, Consumer Durables and Power fell up to 1.43 percent. The Smallcap and Midcap indices also ended in negative territory zone.

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