Mumbai: Indian shares bounced back on Monday along with the rest of the world as investors hoped that the nearly $1 trillion (Rs45 trillion) package cobbled together by the International Monetary Fund (IMF) and the European Union (EU) will contain the Greek debt crisis. But this could just be a relief rally, as markets decipher the implications of the bailout package and the slowdown in China, caution analysts.

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The Sensex rose 3.35% or 561.44 points to close at 17,330.55, the most in 10 months, as foreign investors came back into the fray and traders covered their shorts.

The broader 50-stock Nifty index gained 3.5% or 175.55 points to close at 5,193.6.

Graphic: Ahmed Raza Khan / Mint

Short covering takes place when traders who have sold shares they do not own in anticipation of lower prices buy shares to close the open position. On Sunday, European ministers and IMF officials readied a €750 billion (around Rs44 trillion) package to prevent the Greece crisis spreading to the rest of Europe and stabilizing the currency which has been under attack. Greece is running a 13% fiscal deficit to its gross domestic product and has a debt-to-GDP ratio of 130%. The Indian currency, too, jumped the most in 14 months as the EU-IMF package encouraged investors to return to emerging market assets.

After losing 2.5% last week, the rupee strengthened 1.4% to 44.86 per dollar on Monday—the biggest gain since 19 March 2009.

The rupee is likely to benefit from EU’s emergency fund.

Investors should buy the rupee against the dollar and the euro using non-deliverable forward contracts that mature in three months to gain from India’s improving economy, foreign-exchange strategists at Standard Chartered Plc wrote in a research note on Monday.

As investors bought equities and risk appetite returned, the yield on the government 10-year bond ended at 7.68%, up from its previous close of 7.64%, in line with global bond markets. “It’s simply the reversal of the Greek effect," said N. Sethuram Iyer, chief investment officer at Shinsei Asset Management Co. Ltd that manages Rs222 crore worth of assets. “The problems seem to have been addressed and there won’t be any major fallout of that."

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While the EU and IMF were looking for ways to address the contagion, credit rating agency Standard and Poor’s cut Greek debt to junk on 26 April, which sparked a sell-off in equities worldwide. The Sensex lost close to 5.5% till last Friday, before this rally.

“There was a fair bit of short covering," said Vinod Kumar Sharma, head of wealth management at HDFC Securities Ltd. “The bounce back is also sharp because the assistance to Greece is higher than what the markets imagined."

Graphic: Ahmed Raza Khan / Mint

Equities rallied across Asia with the Jakarta Composite Index gaining 4.06% and Hong Kong’s Hang Seng Index increasing 2.54%. Europe opened sharply with the FTSE100 and DAX index gaining 4.58% and 4.57%, respectively, at 6.30pm IST.

During early trading, the Dow Jones Industrial Average futures climbed 377 points, or 3.7%, to 10,712 and Nasdaq-100 futures surged 4.2% to 1,925.50. Dow futures jumped as much as 421 points, less than their second quarter limit of 550 points.

In India, Reliance Infrastructure Ltd led the gains among Sensex companies with a 8.49% rise. Among the sectoral indices, realty companies were the top gainers with a 6.17% rise, followed by metals with 6.06%.

Still, analysts are not convinced yet that a sharp uptrend will follow Monday’s rally and they prefer to watch for indicators ranging from European governments’ action to the monsoon and company earnings in India.

For one, “the longer-term consequences will take longer to assess and digest... Much will depend on whether or not Euro zone governments quickly follow through on their pledge" to tighten the purse strings, Marco Annunziata, chief economist at the UniCredit Group, told AFP.

“The markets will consolidate at current levels," said Ved Prakash Chaturvedi, chief executive officer at Tata Asset Management Ltd, that has at least Rs22,000 crore under management.

“We are also going through a period of interest rate increases. As earnings direction becomes more clear, we will have a definite view of where the markets will head," he said.

Secondly, analysts are also considering the Chinese slowdown, which could affect short-term fund flows and sentiment of foreign investors towards Asian emerging markets. Chinese manufacturing activity in April expanded at its slowest pace in six months, stoking fears of a slowdown. It's the largest consumer of several industrial commodities and a slowdown in that economy will drive down demand and prices, and reverse stock price gains in this category.

On Monday, the Shanghai Composite—the worst performing major Asian index in 2010—gained just 0.39%, the lowest in Asia except the Philippines. “If China does not do well, it is not good for Asia. It is the biggest player in Asia and a proxy for overall investor sentiment towards Asia more than any other country," said Jahangir Aziz, chief economist at JPMorgan Chase and Co.’s India unit.

Graphic by Yogesh Kumar / Mint

Bloomberg, AFP, Reuters and Ashwin Ramarathinam of Mint contributed to this story.