Oct. 19 (Bloomberg) -- India's Sensitive Index fell, posting its first weekly drop in nine after a government proposal to curb capital flows spurred selling by overseas funds. Reliance Industries Ltd. and ICICI Bank Ltd. led declines.

``The markets will remain very volatile until clarity on the rule-change emerges,'' said Sanjay Dongre, who oversees about $1 billion in stocks at UTI Asset Management Co. in Mumbai.

The Securities & Exchange Board of India will decide on Oct. 25 how to curb the $88 billion of investments made by unregistered investors, including hedge funds, in Indian stocks.

The Bombay Stock Exchange's Sensitive Index, or Sensex, fell 438.41, or 2.4 percent, to 17,559.98. The index slid 4.7 percent this week, its worst drop since the five days ended Aug. 17. The S&P/CNX Nifty Index on the National Stock Exchange declined 135.70, or 2.5 percent, to 5,215.30. Nifty futures for October delivery slid 2.1 percent to 5,205.

Overseas funds sold a net 17.8 billion rupees ($440 million) of Indian shares on Oct. 17, according to the latest figures from the Securities & Exchange Board of India's Web site. That's the first day of net selling since the U.S. Federal Reserve cut rates on Sept. 18 and the most stock sold by overseas funds in two months.

Participatory Notes

The regulator on Oct. 16 suggested that foreign institutional investors should not be allowed to issue or renew offshore derivatives, known as participatory notes, linked to futures and options.

Authorities also want to limit new participatory notes and have proposed to cap the amount that can be issued by each broker.

Hedge funds are not permitted to operate in India, so instead they use derivatives to invest in the country's equities.

``If current or new measures result in a slowdown, whether real or perceived, in near-term foreign institutional investor inflows, it will likely result in the market losing momentum,'' Pratik Gupta, a strategist at Deutsche Bank AG, said in a note to clients yesterday.

ICICI Bank, India's most valuable lender, dropped 14.75 rupees, or 1.4 percent, to 1,024.05, extending a two-day, 10 percent decline. Bharti Airtel Ltd., India's biggest mobile-phone provider, fell 50.95 rupees, or 5 percent, to 968.45, extending yesterday's 7.7 percent fall. They are among the companies that have high components of participatory-note holdings, according to CLSA Ltd.

`Unprecedented Value'

Reliance, which reported a better-than-expected 28 percent increase in second-quarter profit after close of trade yesterday, fell after the oil refiner didn't announce a payout to shareholders.

The share gained 15 percent in seven trading sessions preceding an Oct. 12 shareholders meeting on speculation the company may give free shares in the parent or a rights offer in a retail unit. Reliance dropped 106.7 rupees, or 4.1 percent, to 2,469.20. The company said net income rose to 38.4 billion rupees, exceeding the 33 billion rupee estimate of seven analysts surveyed by Bloomberg News.

Chairman Mukesh Ambani promised shareholders ``unprecedented value'' at the annual meeting on Oct. 12 in Mumbai, prompting speculation the company may offer shareholders additional stock, said R.K. Gupta, a fund manager at Credit Capital Asset Management.

``The market was expecting something more,'' Gupta said today. ``We were expecting a bonus, stock split or a rights issue for Reliance Retail.''

The following shares rose or fell. Stock symbols are in brackets after company names:

ACC Ltd. (ACC IN): India's biggest cement maker fell 44.9 rupees, or 4.3 percent, to 991.10 after Macquarie Securities Ltd. downgraded the stock and analysts cut their earnings forecasts after the company's earnings missed analyst estimates.

Macquarie cut the stock's rating to ``neutral'' from ``outperform'' and reduced its 12-month share price target by 15 percent to 1,048 rupees.

Citigroup Inc. analyst Pradeep Mahtani, who kept his ``sell'' rating, lowered ACC's earnings by as much as 8 percent for 2009 because of an increase in power and fuel costs.

Ambuja Cements Ltd. (ACEM IN) slid 5.6 rupees, or 3.9 percent, to 139.60. India's fourth-largest cement maker reported third- quarter profit that missed analyst estimates. Net income rose 11 percent to 2.92 billion rupees. That lagged behind the 3.45 billion rupee median profit estimate in a Bloomberg survey.

Bajaj Auto Ltd. (BJA IN) gained 51 rupees, or 2.1 percent, to 2,511.65. India's second-biggest motorcycle maker posted an unexpected gain in second-quarter profit after it sold expensive models and raised prices. Net income rose 5.7 percent to 3.36 billion rupees. That topped the 2.85 billion rupee median estimate in a Bloomberg survey of nine analysts.

Hero Honda Motors Ltd. (HH IN) added 20.75 rupees, or 2.9 percent, to 745.35. The country's biggest motorcycle maker posted second-quarter profit that beat analysts' estimates because of higher sales of new models. Net income fell 5.6 percent to 2.04 billion rupees. That beat the 1.84 billion rupee median estimate of analysts surveyed by Bloomberg News. Revenue rose 4.4 percent to 23.91 billion rupees.

Reliance Communications Ltd. (RCOM IN) rose 15.7 rupees, or 2.2 percent, to 727.15. India's second-largest wireless operator gained after the government approved its application to offer services based on the global system for mobile communications. The company becomes the first Indian telecommunications provider to get approval to offer GSM and CDMA mobile-phone services nationwide.

To contact the reporter on this story: Pooja Thakur in Mumbai at pthakur@bloomberg.net.

Last Updated: October 19, 2007 13:33 EDT