MUMBAI (Reuters) - Stocks extended a stunning post-election rally to 20 percent in two days on Tuesday on expectations the ruling coalition's decisive victory will lead to more privatisations, financial sector reforms and increased infrastructure spending.
The rupee also extended gains to a five-month peak, driven by hopes foreign investors would keep buying stocks, but bonds backtracked as worries about how much money the new government would need checked optimism.
In choppy trade after Monday's 17.3 percent surge, the benchmark stock index opened at an 8-month high and then fell back, only to recover again to be up 2.1 percent at noon (0630 GMT).
Top infrastructure play L&T (LT.NS : 1343.15 +111.5) was the major gainer, adding another 14.5 percent to Monday's 25 percent jump, as investors thought it would benefit from a government drive to update the country's creaking infrastructure.
State-run firms such as State Bank of India (SBIN.NS : 1753.95 +177.4) and energy explorer ONGC (ONGC.NS : 995.7 +48.5) also extended Monday's sharp gains as traders bet that the Congress party-led coalition may sell stakes in the firms to help fund spending plans and a large budget deficit.
"From the equity perspective, near-term valuations have become rich and performance relative to other major Asian markets is now decidedly superior," Nomura analysts said in a note.
While the MSCI index of Asian markets excluding Japan has risen about 7.5 percent this month, the Indian market had soared by 25 percent through Monday in the same period.
The spurt brought gains for India's stock market to around 53 percent so far this year, bringing the main index back to levels last seen in early September 2008 before the collapse of Lehman Brotehrs send global markets into a tailspin.
Overall volume in Tuesday morning trade was heavy at about 400 million, close to the daily average so far this year.
Nomura advised caution after the market's jump, saying India's already large budget deficit and the global slowdown meant policy was unlikely to produce a sudden acceleration in growth.
REFORM WISH LIST
The Congress party was expected to appoint reformers to key positions, and analysts expect it to push ahead on stalled reforms that could boost flagging growth in Asia's third-biggest economy.
UBS expects foreign investment limits in the insurance and multi-brand retail sector to be raised, and Citigroup was looking for higher foreign direct investment limits in real estate and a speeding up of infrastructure project approvals.
Citigroup also expected stake sales of state assets in the banking and energy sector, along with some regulation changes.
Not all shares were up on Tuesday, with exporters feeling the pinch of the rupee's sharp gains. The currency has risen 5 percent since last Thursday and 10 percent from a record low hit in early March.
Leading tech sector firms Infosys (INFOSYS.BO : 1563.75 -206.1), Wipro (WIPRO.NS : 385.35 -31.6) and Tata Consultancy (TCS.NS : 669.75 -74.1), who earn most of their income overseas, led losses on worries the rupee's rise would hit their earnings.
YIELDS RISE
Bonds lost Monday's momentum after the central bank increased the size of two scheduled auctions this month to 150 billion ($3.2 billion) rupees each from 120 billion rupees.
Planned record government borrowing unsettled debt markets in February and March, and they remain vulnerable to any suggestion of increased bond issuances to fund the fiscal deficit.
The benchmark 10-year bond yield jumped 12 basis points to 6.43 percent in opening trades, but later trimmed the rise to eight basis points.
"We may briefly test 6.50 percent today, but unless supply fears materialise into fiscal profligacy, I don't see yields moving much higher, but the budget will be the decider," Churchil Bhatt, a bond dealer at ING Vysya Bank.
Five-year swap rates rose to 5.66/67 percent from Monday's close of 5.48/5.53.
The partially convertible rupee rose to five-month high of 47.27 as it extended Monday's 3.2 percent jump, but pared gains as importers bought dollars and traders worried the Reserve Bank may step in to check gains.
The rupee has ridden a revival in foreign flows into the stock market. Foreign funds have been net buyers of more than $4 billion of shares since mid-March.
Nomura sees the rupee strengthening to 46.5 by end 2009.
Three-month annualised dollar/rupee forwards eased to 3.30 percent from 3.34 percent at its previous close on hopes of soft interest rates. One-month rupee volatilities was at 14 percent, unchanged from last week.
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