"The policy decision is a clear indicator of the government's intent to support the market. This has helped investor confidence," said Rajiv Choksey, vice-president at K.R. Choksey Securities.
The 30-issue Mumbai share index closed up 2.13 percent at 6,555.94 points - its best close since January 4 and taking gains in the past four trading sessions to 7.4 percent. The marker is still down 2.1 percent from a historic high of 6,696.31 points struck earlier this month.
"The undertone is very bullish after the government's provident fund decision," said Anil Agarwal, institutional dealing at Lohia Securities Ltd.
Leading the rally on Monday was Tata Motors Ltd, the nation's top truck and bus maker, which climbed 2.6 percent to 504.75 rupees after it reported a higher-than-expected rise in third-quarter quarter net profit to 3.16 billion rupees.
Cement makers rallied on expectations of robust shipments in January, ahead of the data due to start from Tuesday.
Grasim Industries Ltd, the top cement group, rose 0.9 percent to 1,328.20 rupees and Associated Cement Companies Ltd, the No 2 maker, rallied about 2 percent to 357.35 rupees.
But ITC Ltd, the top cigarette maker, fell 2.8 percent to 1,361.85 rupees, after a finance ministry official said the company would have to pay 4.49 billion rupees as excise tax within 30 days.
Federal bonds inched up, helped by weaker oil prices, but traders said an expected issuance of 50 billion rupees and a much-awaited US interest rate decision later this week kept gains muted.
The yield on the benchmark 10-year, 7.38 percent bond eased to 6.7012 percent, lower than Saturday's close at 6.7118 percent. It ended at 6.7337 percent on Friday.
NYMEX crude oil for March delivery was at $46.13 a barrel, down nearly $1 on Monday, after Opec decided to leave production unchanged at the weekend.
Oil, India's biggest import item, has been one of the main drivers of inflation, which touched a 3-1/2-year peak in August and forced the central bank to raise interest rates for the first time in four years.
The rupee gave up earlier gains to end steady as dollar inflows that accumulated over the weekend and fresh foreign investment into the stock market were offset by month-end demand from local companies and the greenback's rise overseas.