The BSE Sensex posted its biggest single-day gain in three months, as investor confidence received a boost from the government's move to initiate reforms and on hopes that the eurozone debt crisis will be tackled with definite measures.
Traders also said investors rushed to cover short-positions in financial and export-driven software services company stocks that had been beaten down during a four-week market slide.
The main 30-share benchmark index rose 3 percent - its biggest percentage gain since Aug. 29 - or 471.7 points to close at 16,167.13, with all but two of its components closing higher. The index has lost 21 percent so far since the beginning of 2011.
Top lender State Bank of India ended up 5.3 percent, while rivals ICICI Bank and HDFC added 4.4 percent and 2.3 percent, respectively. Leading software services exporter Tata Consultancy Services rose 2.3 percent, Infosys firmed 1.4 percent and Wipro closed up 0.6 percent.
The rise was underpinned by gains in world stocks which were helped by hopes that Europe will come up with some concrete steps this week towards activating a crucial eurozone bail-out fund and reports that the International Monetary Fund is considering helping Italy.
Traders said the local market was oversold and the positive trends elsewhere were further supported by domestic factors such as last week's government decision to allow global supermarket giants such as Wal-Mart Stores Inc. and Tesco to enter India with a 51 percent stake.
There is a fresh relief that the government's action has brought in as it gives the feeling that India will push for more reforms and that is a positive sign which is being sent out, said Jagannadham Thununguntla, strategist and head of research at brokerage SMC Global.
The opening up of the retail sector was the biggest reform in years by the ruling coalition.
However, I think the bounceback in the market is temporary as the overall global economic scenario still looks bleak, Thununguntla said.
The market has seen heavy selling by foreign institutional investors in recent sessions, who have pulled out $739 million over four sessions to Thursday, data from the market regulator showed. The market is now awaiting economic growth data due on Wednesday and the central bank's mid-quarter policy on Dec. 16 for further cues, traders said.
The 50-share NSE index ended up 3 percent at 4,851.3. In the broader market, there were 3.2 gainers for every loser on volume of about 538.8 million shares.
In the short-term this rally may sustain and the market could go up to 5,000 if there is continued positive newsflow from overseas, Jigar Shah, senior vice-president with KIM ENG Securities. But we are negative as there is no quick-fix solution to the situation in Europe immediately and secondly going by the depreciation in the rupee we do not think inflation will be tamed easily, he added.
Property developer DLF, which could benefit from demand for malls as foreign investment in multi-brand retail picks up, closed 3 percent higher, adding to gains of nearly 5 percent over two sessions.
Retail stocks such as Pantaloon Retail ended down 4.6 percent after soaring more than 30 percent over two sessions. Shoppers Stop fell 7 percent and Trent also ended 3 percent down on profit-taking.
Axis Bank closed up 2.5 percent. The private-sector lender said it was monitoring exposure to infrastructure projects and was choosy about large projects.
Energy major Reliance Industries, which has the heaviest weight on the main index, rose 3.98 percent. Suzlon Energy rose more than 3.8 percent after it signed a contract for a 75 megawatt power project worth 4.7 billion rupees.
MSCI world equity index gained 0.9 percent, rising for the first time after ten consecutive days of losses.
STOCKS THAT MOVED
* Punj Lloyd jumped 6.3 percent after the company said that it has bagged an offshore contract worth 4.69 billion rupees from ONGC.
* Coal India rose 4.5 percent after television reports on Monday the government has floated a cabinet note to consider buyback of shares in cash-rich public sector companies as a route to achieve the divestment targets.
* Thomas Cook India rose 9 percent after its parent Thomas Cook Group Plc secured new funding from its banks, easing fears about its future.
* Steel Authority of India rose 4 percent after the Financial Chronicle newspaper reported the company was in talks with two or three possible targets in New Zealand and
Australia to buy coking coal assets, traders said.
MAIN TOP 3 BY VOLUME
* Suzlon Energy on 20.4 million shares
* NHPC on 16.8 million shares
* Sujana Towers on 16.5 million shares