Indian stock markets have plunged sharply after the country's Central Bank tightened monetary policy. Mumbai's Sensex index fell 617 points, to reach 12,455 points. As Anjana Pasricha reports from New Delhi, the market slid on fears that the Indian economy could slow down.

Equity advisor watches share prices at financial consultants' firm in Mumbai, 2 Apr 2007

The Mumbai Stock Exchange's 30-share Sensex plummeted by nearly 5 percent.

The market plunged after the central bank, the Reserve Bank of India, raised its lending rate by a quarter percentage point, from 7.5 to 7.75 percent.

This prompted several banks to announce that they will hike interest rates.

It was the second time that the central bank raised lending rates in three months. Interest rates are at their highest level in four years.

Stockbroker Rajesh Jain, of Pranav Securities, says domestic and foreign investors are concerned that higher interest rates will weaken demand for shares.

"The impact of higher interest rate is likely to cause demand pull back in the economy and is really likely to shrink the liquidity flow which was driving the stock markets," he explained. "With a bit of a slowdown, you may not see the kind of corporate growth numbers you saw in the last financial year. "

The central bank says raising interest rates is aimed at tackling inflation of about 6.5 percent.

The central bank has been raising interest rates in recent months to slow down lending by commercial banks. Ready availability of cheap loans has boosted demand for everything from cars to homes. But this has led to higher prices and heightened fears that the economy could be overheating.

The government has supported the bank's move, saying that lowering prices is its key priority. High inflation is cited as the reason for the ruling Congress Party's electoral losses in two states recently. The Congress Party faces another crucial poll in Uttar Pradesh state later this month.

But there are fears the move by the Central Bank could dampen fresh investment and eventually slow an economy that has been growing at more than 9 percent in recent years.