The rupee, which had breached the key 55 to the dollar mark in trade earlier, however pared losses and traded at 54.87 as of 3.48 p.m.
Traders attributed the sharp cut to profit taking. Market analyst Sarvendra Srivastava said the correction was warranted as the up move was very fast. The benchmark Sensex had gained nearly 10 per cent since mid-April, helped by a surge in foreign buying.
Sentiments turned for the worse after data showed April's trade deficit widened to $17.8 billion. Gold and silver imports were up by 138 per cent to $7.5 billion last month compared to a year earlier, as retail consumers in the world's biggest gold importer went on a buying spree after global prices fell.
Weaker Asian shares also weighed on sentiment after data showed China's factory output growth was surprisingly feeble in April and fixed-asset investment slowed. Hong Kong's Hang Seng benchmark closed 1.4 per cent lower. European markets opened deep in the red.
Analysts, however, remained bullish despite the sharp selloff today. Mr Srivastava said Monday's correction was not supported by huge volumes, which is a good sign. He sees the danger of bears staging a comeback only when the Nifty closes below the 5,920-5,930 mark.
Tobacco major ITC was largely responsible for the large cut in Sensex and Nifty today. ITC has the biggest weightage on the benchmark indices and it contributed 122 points on the downside on Monday..
ITC shares closed 5.2 per cent lower after gaining 7.7 per cent in May, as of Saturday's close. All Nifty stocks closed lower.
Capital goods, auto, IT and banking stocks were also hit besides FMCG. Reliance Infra, Bharti Airtel and Tata Steel slipped 4-5 per cent.
Technology stocks such as Tata Consultancy fell on continued concerns about the U.S. Immigration Bill.