The benchmark Sensex gained 451 points on Monday, the most in a month, as overseas stocks advanced on China's proposed economic reforms and expectations the US stimulus programme would be extended.
The rupee, which strengthened against the dollar for the third day, also supported local equities, which traded after a holiday on Friday.
The S&P BSE Sensex opened 171 points higher and stayed in positive territory through the day and ended at an almost two-week high of 20,850.74, a rise of 451.32 points, or 2.21 per cent. It was the biggest gain since October 18.
Capital goods and bank stocks led all 13 BSE sectoral indices higher. HDFC Bank and Larsen & Toubro led gainers on the Sensex, which was boosted by ITC and Reliance Industries.
"Positive global cues, optimism from US that they are not in hurry to taper stimulus programme and a stronger rupee fuelled the rally. Banking and auto stocks were in favour," said Rakesh Goyal, Senior VP at Bonanza Portfolio Ltd.
The Hong Kong Hang Seng Index surged 2.73 per cent and the Shanghai Stock Exchange Composite Index rose 2.87 per cent amid a firming trend in Asia after China's government said it would carry out broad reforms.
US stocks gained on Friday after Federal Reserve nominee Janet Yellen indicated the $85 billion of monthly bond purchases would continue, raising hopes of higher capital inflows in India and other emerging markets.
Brokers said sentiment also turned bullish as the rupee recovered. The RBI plans to inject Rs 8,000 crore into the financial system in bond purchases on Monday to ease liquidity.
The CNX Nifty on the National Stock Exchange rose 132.85 points, or 2.19 per cent, to 6,189. The SX40 on the MCX Stock Exchange closed 247.21 points up at 12,366.6.
Even as UBS downgraded Indian stocks to "neutral" from "overweight," the government said it needs to take more measures to give momentum to growth, which was affected by the global financial crisis in 2008.
"We acknowledge that more needs to be done," said Economic Affairs Secretary Arvind Mayaram said.
In Europe, stock markets were mixed in the afternoon. France's CAC was quoted up, while indices in Germany and the UK were lower.
The rupee ended at 62.41, up 70 paise from Thursday's close, the third day of gains.
Foreign institutional investors bought shares worth a net Rs 970.03 crore on Thursday, according to provisional data from the stock exchanges.
"There was unprecedented euphoria in the Indian markets today," said Jignesh Chaudhary, Head of Research at Veracity Broking Services. "In the absence of retail investors, FIIs are finding it very difficult to exit Indian markets."
Of the 30 Sensex stocks, 26 advanced, led by HDFC Bank (4.15 per cent ), Larsen & Toubro (3.9 per cent ), ITC (3.61 per cent ), Hindalco Industries (3.34 per cent) and ONGC (3.22 per cent).
Losers on the index included Sesa Sterlite (-1.36 per cent) and Coal India (-1.15 per cent).
Among the S&P BSE sectoral indices, Capital Goods rose 3.19 per cent, followed by Bankex 3.15 per cent, FMCG 2.52 per cent, Realty 2.41 per cent and Oil & Gas 2.34 per cent.
The market breadth remained positive as 1,449 stocks gained, 1,085 fell and 132 ruled steady. Total turnover rose to Rs 2,037.12 crore from Rs 1,850.06 crore last Thursday.