Sensex rallies over 400 points on strong foreign fund buying

REUTERS - The Sensex and Nifty rose nearly 2 percent, posting their biggest daily gain in over three months, while bonds also rallied, on hopes that foreign investors would continue to buy into markets despite uncertainty about the outlook for U.S. interest rates.

The strong gains on Thursday made India an outlier given that other emerging Asian markets fell after the Federal Reserve suggested it could raise interest rates faster than expected when it starts increasing, although it renewed its pledge to keep borrowing costs low for a "considerable time."

Traders cited speculation of strong inflows into India, with investors noting the country could better weather any Fed-related volatility due to a recovery in domestic economy and the government's efforts to rein in deficit.

"Foreign institutional investors are finding a lot of love for Indian shares on cyclical recovery story," said Atul Kumar, head of equity funds at Quantum AMC.

The BSE Sensex gained 1.66 percent, while the broader Nifty rose 1.63 percent, heading towards their biggest daily gains since June 2.

That contrasted sharply with the 0.6 percent fall in MSCI Asia-Pacific ex-Japan.

Foreign portfolio investors have been the key drivers behind indexes that hit their record highs on Sept. 8, having bought a net $14.14 billion in shares so far this year, according to regulatory data.

Traders said the election of Prime Minister Narendra Modi had sparked strong hopes about a recovery in the business environment and the broader economy. Meanwhile, the Reserve Bank of India's efforts to control inflation have also raised investor optimism.

However, recent data has been mixed. India's industrial output growth hit a four-month low in July while inflation remained high, underscoring the struggle of Asia's third-largest economy to make a sustained recovery from its longest stretch of sub-par growth in decades.

Some investors have also been disappointed about the lack of significant reforms from the Modi government, although analysts noted markets are willing to be patient.

"India should show actual results when the going is good. Valuations are rising and asset gains are not in sync with earnings reality," said Aneesh Srivastava, chief investment officer at IDBI Federal Life Insurance.

Still, for now foreign investors are willing to bet into India, including in bonds. Foreign investors have bought Indian debt worth $18.67 billion so far in 2014.

The benchmark 10-year bond yield fell 4 basis points to 8.46 percent, its lowest since July 28, while the rupee was up 0.06 percent

(Reporting by Abhishek Vishnoi; Editing by Anand Basu)