The BSE Sensex surged nearly 850 points to a day high of 28,194, after Reserve Bank Governor Raghuram Rajan lived up to his credo of "never say never" by announcing an unexpected 25-basis-point cut in benchmark repo rate.
Anand Mahindra, chairman of India's biggest utility vehicle maker M&M, tweeted, "Three cheers! The RBI Governor has moved from being 'Reluctant Raghu' to 'Rate-cut Raghu'!".
Sensex closed 728.73 points, or 2.66 per cent higher at 28,075.55, its biggest point gain since May 4, 2009. Nifty surged 216.60 points or 2.62 per cent to end at 8,494.15.
Forty-six of the 50 Nifty shares ended higher reflecting the optimism in markets.
Gains were led by rate sensitive stocks such as realty, banks and auto. Shares of real estate developers surged on hopes that lower rates will drive demand for homes. DLF, India's biggest listed realty firm, jumped 10.84 per cent.
The Bank Nifty, the blue chip index of banking stocks, closed 3.4 per cent higher after hitting an all-time high earlier in the day on hopes of greater credit offtake. IDFC, HDFC and SBI ended with over 5 per cent gains.
Auto stocks also rallied sharply on hopes of rising demand amid lower loan rates. M&M shares closed 3.3 per cent higher, while Maruti Suzuki added 3.12 per cent.
Explaining the sharp gains in markets, Sonal Varma of Nomura said, "The shift in RBI monetary policy stance towards easing should lead the market to price in further rate cuts. This would support a pickup in local growth momentum and further raise the prospects for foreign portfolio inflows."
Morgan Stanley economists expect a further 125 basis point rate cut over the next 12 months. "Our rate cut forecast is predicated on our view that retail inflation will stay at closer to 5 per cent in most of the calendar year 2015, as the reduction in fiscal deficit, sustained deceleration in rural wages and lower global commodity prices will mean that inflationary pressures in the economy will be contained," said Chetan Ahya of Morgan Stanley.
Motilal Oswal, chairman of the eponymous financial services firm, tweeted, "This rate cut is a beginning of a series of rate cuts by RBI given Rajan's commitment to not flip-flop once he begins the process."