Sensex surges 25.7 percent in 2012; best in three years

MUMBAI (Reuters) - The BSE Sensex edged lower on Monday due to caution over the U.S. "fiscal cliff" talks, but ended 2012 with its best gains in three years as strong foreign inflows and the government's fiscal and economic reforms outweighed worries about the domestic economy.

Foreign investors have pumped in over $24.2 billion this year, marking the biggest inflows since a record $29.36 billion in 2010, on the back of cheaper valuations and government measures to further open up the retail and aviation sector.

Indian stocks could gain further next year due to expected interest rate cuts from the Reserve Bank of India and on improved earnings, while investors are also gearing up for a potential revival in initial public offerings.

However, challenges remain, including over-leveraged banking and corporate sectors as well as the prospect of a sovereign ratings downgrade should the government fail to get its finances under control.

"Most important challenge is of fiscal deficit which will remain in 2013," said Vaibhav Sanghavi, director at Ambit Capital.

Fiscal deficit in combination with current account deficit will impact the exchange rate going forward, Sanghavi added.

The benchmark BSE index fell 0.09 percent, or 18.13 points, to end at 19,426.71 points on Monday, but surged 25.7 percent for the year to mark its biggest gain since 2009.

The broader Nifty ended down 0.06 percent, or 3.25 points at 5905.10, but was up 27.70 percent in 2012.

Gains could continue next month amid expectations the RBI will cut interest rates for the first time since April, benefitting sectors such as banks and property that have already outperformed this year. For best, worst performers, click link.reuters.com/gar84t

The government is also expected to continue its drive to sell stakes in companies, including state-run Oil India and NTPC Ltd, while companies such as BSE Ltd are planning to list.

Although earnings are expected to rebound on the back of an improving economy, some sectors are still seen weak, including India's $100 billion technology sector, which is being hit by weakening global demand.

Concerns that U.S. lawmakers may fail to clinch a solution to the U.S. "fiscal cliff" would weigh on domestic markets.

Technology stocks were among the leading decliners, with HCL Technologies falling 1.21 percent while Tata Consultancy Services (TCS.NS) fell 0.9 percent.

Among other decliners, profit-booking hit blue chip ITC sending the cigarette maker down 0.9 percent on Monday, after gaining 43.77 percent this year as of Friday's close.

ICICI Bank (ICBK.NS), the best perfroming blue-chip bank, fell 0.3 percent. Its shares have surged 66.73 percent this year as of Friday's close.

However, among gainers, Tata Motors (TAMO.NS) gained 0.84 percent ahead of monthly sales data due on Tuesday amid expectations of an improved performance.

Wipro Ltd (WIPR.NS) gained 0.6 percent after shareholders approved its demerger plan following a meeting on Friday.

Oil and Natural Gas Corp (ONGC.NS) ended up 0.83 percent, extending Friday's 2.6 percent gain on hopes of fuel price hikes.

Bharti Infratel Ltd (BHRI.NS) rose 1.1 percent after the FTSE said on Friday it would include the mobile tower company in its large cap index starting on January 7, with an investability weighting of 9 percent.

(Editing by Sunil Nair)