The BSE Sensex erased gains in late trade on Thursday and dropped for a second session in a row on concerns quarterly results starting next week will mostly show a sharp drop in earnings growth and will weigh down the market in the near term.
Expectations moderating inflation will allow the Reserve Bank of India to begin cutting interest rates drove shares higher for most of the day, before investors turned cautious towards the close.
Slowing inflation has increased hopes of a reversal in the interest rate cycle, but all eyes are on the upcoming earnings season, said Jagannadham Thunuguntla, head of research at SMC Global.
The market is expecting more negative surprises than positives.
Most companies have struggled in the past quarter after a spate of rate rises dented consumer spending, while a slump in the rupee's value poses a big burden for companies with large foreign borrowing.
The main 30-share BSE index ended down 0.16 percent, or 25.56 points, at 15,857.08, after rising as much as 0.6 percent during trade. Seventeen of its components closed down.
The benchmark, which fell nearly a quarter in 2011, rose more than 3 percent in the first two sessions of the new year, before retreating on Wednesday.
Credit Suisse upgraded Indian equities to neutral from underweight, citing cheap valuations, easing headline inflation and slower earnings estimate downgrades in December.
Data on Thursday showed the food price index declined for the first time in nearly six years, raising hopes the December headline inflation rate will drop below 9 percent for the first time in more than a year.
Still, macro imbalances will cap the upside potential, investment bank RBS said.
The challenges faced by India are multi-fold, ranging from twin deficits and a high ratio of debt to GDP to persistent inflationary pressure and a weak currency, it said in a report.
Energy major Reliance Industries (RELI.NS) led the fall in the main index and ended down 2.3 percent, while Coal India (COAL.NS) shed 1.9 percent.
Utility and tractor maker Mahindra & Mahindra (MAHM.NS) rose 1.7 percent, ICICI Bank (ICBK.NS) gained 0.7 percent, engineering conglomerate Larsen & Toubro (LART.NS) firmed 1.7 percent on expectations borrowing costs will come down.
Momentum indicators show inflation is slowing, and the ceiling for interest rates has been reached, Reserve Bank of India Deputy Governor Subir Gokarn said on Thursday.
The central bank, which raised interest rates 13 times between early 2010 and last October before pausing in December, is scheduled to review monetary policy on January 24.
The broader 50-share NSE index ended up 0.01 percent at 4,749.95. In the broader market, there were 1.2 losers for every gainer on volumes of 521.3 million shares.
STOCKS THAT MOVED
* Real estate developer DLF (DLF.NS) fell 3.9 percent as market players built short positions in the January futures contract.
* Cash-strapped Kingfisher Airlines (KING.NS) dropped 2.6 percent after the aviation regulator said it was seeking an explanation on safety concerns raised in an internal report. After the market closed, the regulator said it did not intend to cancel the licence of any carrier.
* Orissa Minerals Development Co (ORIS.NS) rose 1.3 percent after it resumed development and mining operations at two of its mines in the eastern state of Orissa.
* Brigade Enterprises (BRIG.NS) rose 8.4 percent after the Press Trust of India reported the company is looking to raise around 1.5 billion rupees through private equity.
MAIN TOP 3 BY VOLUME
* Suzlon Energy (SUZL.NS) on 30.6 million shares
* Tata Motors (TAMO.NS) on 21.4 million shares
* Jaiprakash Associates (JAIA.NS) on 21 million shares