The Sensex, which had opened higher, lost steam and dropped to 17,019.24 as the rating agency lowered the sovereign credit outlook from stable to negative on risks from slower economic growth and a widening current-account deficit.
Traders said funds cutting positions ahead of the upcoming monthly expiry in derivatives segment also pushed Sensex downwards.
However, late buying in fundamentally strong stocks at lower levels after Finance Minister Pranab Mukherjee said there is no need to panic as the government is committed to economic reforms, helped the stock market pare some losses. A firm trend in overseas markets also provided support.
The 30-share BSE barometer erased a part of its intra-day losses and settled 56 points lower, or 0.33 per cent to 17,151.29 on lower closing in stocks of consumer durable, IT and realty sectors.
Similarly, the broad-based National Stock Exchange index Nifty lost 20.65 points, or 0.40 per cent to 5,200, after dipping to 5,160.65.
Wipro Ltd., the country's third-largest software exporter dropped 7.29 per cent to Rs 410.15 after the company's forecast for revenue in the first quarter came below market expectations.
Sensex heavyweight Reliance Industries, which gained 0.22 per cent to Rs 736.35, partly cushioned the market fall.