The BSE Sensex dropped 1.5 percent on Tuesday to its lowest close in seven months, as rising borrowing costs and high inflation drove investors to cut their exposure and move elsewhere.

Financials led the fall on worries higher interest rates would dampen demand for loans and hit their margins.

Engineering and construction firm Punj Lloyd tumbled 10.8 percent after it posted a net loss for the December quarter. Around 4.3 million shares changed hands on the BSE, nearly six times its 30-day average volume.

Analysts said with foreign funds pulling out more than $1 billion from Indian equities since the start of January, the outlook for the near term remained subdued.

"The next big trigger is the budget," said Rakesh Rawal, head of private wealth management at Anand Rathi Financial Services, referring to India's annual budget that will be presented to parliament at the end of this month.

"If the budget brings cheer, we may see positive reaction. But until then any decent upside does not seem likely."

The 30-share BSE index fell 1.45 percent or 261.49 points to 17,775.70, its lowest close since July 8. Twenty-five of its components lost ground.

The banking sector index shed 2.3 percent. Subir Gokarn, a deputy governor at the Reserve Bank of India, said on Monday that the monetary policy stance remained

anti-inflationary, as headline inflation at 8.43 percent continues to be high.

So far this year, the BSE index has lost 13.3 percent, making it the worst performer amongst its peers in Brazil, Russia and China, on foreign fund outflows of $1.3 billion.

In comparison, Brazi's Bovespa and China's Shanghai Composite Index have dropped 5.7 percent and 0.3 percent respectively. Russia 's RTS index has registered an 8.7 percent gain in year-to-date.

Investors spurned emerging market equities, moving more cash into developed market stocks on a brightening economic environment, fund-tracker EPFR Global said on Friday.

For the week to Feb. 2, BRIC equity funds had net outflows of $316 million, a 10th consecutive week of redemptions.

Top lender State Bank of India fell 0.9 percent, while rivals ICICI Bank and HDFC Bank dropped nearly 3 percent and 1.7 percent respectively.

Metal makers fell as London copper declined ahead of the return of China from a week-long holiday, and the rally of the past two weeks that reached a record high may have peaked for a while as technical indicators turn bearish.

Tata Steel, the world's seventh-largest steel maker, fell 3.2 percent and non-ferrous metals producer Sterlite Industries lost 2.5 percent.

Market breadth was weak with more than four shares declining for every share that advanced on low volume of 238 million shares.

The 50-share NSE index shed 1.6 percent to 5,312.55.

At 1024 GMT, the MSCI world equity index and Thomson Reuters global stock index were up 0.2 percent each.

STOCKS THAT MOVED

* Fortis Healthcare rose 5.3 percent to 147.40 rupees after the hospital operator said its December quarter net profit rose 58.7 percent.

* Prestige Estate Projects rose 4.6 percent to 131 rupees after Citigroup initiated coverage on the real estate developer with a "buy" rating and a target price of 170 rupees on the back of strong execution track record of the company.

MAIN TOP THREE BY VOLUME

* Unitech on 7.2 million shares

* Suzlon Energy on 6.6 million shares

* Lanco Infratech on 5.4 million shares