The BSE Sensex rose nearly 1 per cent on Wednesday to mark its second straight day of gains on continued foreign inflows, while stocks perceived as defensive gained ahead of the conclusion of the U.S. Federal Reserve meeting later in the day.
Markets expect the U.S. central bank to announce a slight reduction in its $85 billion monthly bond-buying programme, while stressing that interest rates will stay low for a while.
The focus will next shift to Reserve Bank of India's monetary policy review on Friday. Dealers would be interested to see new Governor Raghuram Rajan's stance on the emergency cash tightening steps the central bank initiated in mid-July.
He is expected to leave key policy rates unchanged in his first policy review, continue with the cash tightening measures to stabilise the rupee, and focus on checking runaway inflation, a Reuters poll showed.
"More than the RBI policy, the Fed is in focus because our biggest problem is rupee instability and RBI doesn't have enough balance to support the rupee," said G. Chokkalingam, managing director and chief investment officer at Centrum Wealth Management.
Local monetary policy efforts would be to mitigate damages, if any, due to global developments, Chokkalingam added.
Foreign institutional investors bought $55.44 million worth of Indian shares on Tuesday, data from the markets regulator showed, totalling more than $72 billion rupees worth of buying over the previous nine sessions.
The Sensex rose 0.8 per cent, or 158.13 points, to end at 19,962.16, marking its second consecutive day of gains.
The broader Nifty rose 0.84 per cent, or 49.25 points, to end at 5,899.45.
Goldman Sachs, however, remains "underweight" on Indian shares in its Asia Pacific portfolio and maintains its NSE index target at 5,700, saying the macro outlook remains challenged, which coupled with tighter financial conditions, may lead to lower valuations.
Shares in consumer goods makers and drug companies, perceived as defensive, gained as anxiety built up ahead of the close of the Federal Open Market Committee (FOMC) meet.
Cigarette maker ITC Ltd gained 1.4 per cent, while Hindustan Unilever Ltd rose 2.2 per cent.
Dr.Reddy's Laboratories Ltd gained 2.1 per cent following the U.S. drug regulator's approval for selling a generic version of Celgene Corp's anti-cancer drug Vidaza. DRL shares rose 3.6 per cent on Tuesday.
Ranbaxy Laboratories Ltd gained 1.4 per cent on value buying for the second day after a ruling from the U.S. health regulator on its Mohali factory triggered the worst single-day fall in its stock on Monday, wiping off a third of its market value.
Other pharmaceutical shares gained too. Cipla Ltd ended 1.2 per cent higher, while Sun Pharmaceutical Industries Ltd rose 0.9 per cent.
GMR Infrastructure Ltd rose 2.3 per cent, adding to Tuesday's 2.1 per cent gain after the company said it had sold its majority stake in a highway construction unit for about 2.22 billion rupees, which will help the company reduce its debt.
Coal India Ltd rose 1.3 per cent on expectations of positive announcements from its annual shareholders meeting later in the day, dealers said.
JSW Steel Ltd shares rose 0.8 per cent after J.P. Morgan upgraded the stock to "overweight" from "neutral" and raised its target price to 850 rupees from 720, citing rupee boost to export earnings followed by margin expansion from new projects.
Among stocks that fell, HCL Technologies Ltd lost 0.8 per cent, falling for a third session in four, on profit-taking after hitting its all-time high of 1,081.85 rupees on September 12.
Non-banking lenders slumped for a second day after the Reserve Bank of India tightened rules for loans against gold on Monday.
Muthoot Finance Ltd fell 6.4 per cent, adding to Tuesday's 8 per cent plunge, while Manappuram Finance Ltd fell nearly 5 per cent for the second day.
Fed likely to reduce bond buying, pass policy milestone
The Federal Reserve is expected to begin its long retreat from ultra-easy monetary policy on Wednesday by announcing a small reduction in its bond buying, while stressing that benchmark U.S. interest rates will remain near zero for a long time.
Most economists think the Fed will opt to scale back its monthly purchases of Treasury and mortgage-backed securities by a modest $10 billion, a Reuters poll found.
That would take them to $75 billion and signal the beginning of the end to an unprecedented episode of monetary expansion that has been felt worldwide.
The baby step would begin to provide a bookend of sorts to the U.S. central bank's response to the global financial crisis that reached fever pitch five years ago this week with the collapse of investment bank Lehman Brothers.
"It is an important milestone ... juxtaposed against five years ago, when the Fed began the huge expansion of its balance sheet," said Carl Tannenbaum, chief economist at Northern Trust in Chicago. "This is going to be the first step, potentially, in a very, very long walk."
The Fed will announce its decision in a statement following a two-day meeting at 2 p.m. (1800 GMT), and Fed Chairman Ben Bernanke will hold a news conference a half hour later. It is also set to release fresh quarterly economic and interest rate projections.
In slashing overnight rates to zero in late 2008, the Fed launched an extraordinarily bold campaign to shelter the U.S. economy. The effort included three rounds of bond purchases that more than tripled its balance sheet to around $3.6 trillion.
The actions, unthinkable to many within the Fed prior to the crisis, sparked intense criticism from those who feared the measures would create an asset bubble or fuel inflation.
But the Fed's show of force was credited with saving the U.S. and world economies from a much worse fate.
With the U.S. economy now on a somewhat steady, if tepid, recovery path and unemployment falling, policymakers have said the time was drawing near to begin ratcheting back their bond buying with an eye toward ending the program around mid-2014.
Incoming economic data has been mixed, with a disappointing reading on Wednesday on housing starts potentially pointing at some slackening in the housing recovery after mortgage rates rose in anticipation of less Fed stimulus.
The nation's latest monthly employment report was also lukewarm. The jobless rate declined to 7.3 per cent in August, but that was because more people left the workforce, rather than as a result of much stronger hiring.
While Treasury bond yields and mortgage rates have shot higher in recent months, the Fed will still be expanding its balance sheet for months to come as it tries to wean the economy and financial markets from its ever-expanding stimulus.
Yellen and forward guidance
To temper any jitters the bond market may feel from a slowing in the Fed's purchases, Bernanke is expected to reinforce the bank's commitment to keep overnight rates near zero for a long time to come at what is likely his penultimate news conference before stepping down in January at the end of his term.
The guidance on rates is aimed at holding down longer-term borrowing costs, which encompass investors' views on the path of short-term rates.
That task may have gotten easier after former U.S. Treasury Secretary Lawrence Summers withdrew from the running to replace Bernanke when his term ends on January 31, restoring current Fed Vice Chair Janet Yellen to the front-runner position.
"To the extent that there is an effective tool, it's forward guidance," Goldman Sachs Chief Executive Lloyd Blankfein told CNBC on Wednesday. "Forward guidance is more credible if it emanates from an institution that is going to have continuity."
The Fed has said it will not begin raising rates at least until the unemployment rate falls to 6.5 per cent, provided inflation does not threaten to go above 2.5 per cent.
Some analysts wonder if the Fed might try to hammer home the message that rates would stay lower for longer by reducing the unemployment threshold to 6.0 per cent.
But it could prove hard for Bernanke to muster sufficient support from other members of the central bank's policy-setting committee for such a move.