* BSE index gains 1.27 pct, NSE index adds 1.18 pct
* Both indexes hit record high and record closing high
* Power, infrastructure and state-run cos gain
By Indulal PM
MUMBAI, July 2 (Reuters) - Indian shares surged more than 1 percent to hit record highs on Wednesday after Finance Minister Arun Jaitley's warning against "mindless populism" raised hopes the government would unveil a fiscally prudent budget next week.
Jaitley on Tuesday also said a high fiscal deficit and inflation are major challenges for India, further soothing market sentiment ahead of the budget to be unveiled on July 10.
Among the top gainers were sectors expected to receive support in the budget such as power and infrastructure, including Larsen and Toubro and Bharat Heavy Electricals Ltd.
Overseas investors who pumped in about $10 billion so far in Indian shares this year, bought shares worth $142.8 million for the third straight day on Tuesday, exchange and regulatory data showed.
"It's a pre-budget rally and the government is giving enough signals on how it is going to deal with the economy. Market is taking cues from there and expectations are very high. Though we are positive, we advise clients to be cautious and selective as selling pressure can emerge on any negative news," said Suresh Parmar, head, institutional equities, at KJMC Capital Markets.
The benchmark BSE index closed up 1.27 percent at 25,841.21 points. Earlier in the day, it surged 1.37 percent to hit a record high of 25,864.53 points, surpassing its previous life high of 25,735.87 hit on June 11.
The broader NSE index gained 1.18 percent to close at 7,725.15 points, having hit a fresh record high of 7,732.40 points earlier in the session, breaching its previous peak of 7,700.05, also hit on June 11.
Shares in the power and infrastructure sectors, widely expected to be among the biggest focus areas for the new government, rallied. NTPC Ltd closed 3.33 percent higher, Tata Power Co. Ltd ended up 0.9 percent and Larsen and Toubro Ltd gained 1.6 percent.
The sub-index of state-run companies also gained 1.22 percent on hopes of reforms and divestment. Container Corp of India gained 3.3 percent while Rural Electrification Corp ended 3.8 percent higher.
Among blue-chips, Reliance Industries Ltd gained 1.02 percent and Sun Pharmaceutical Industries Ltd ended 2.1 percent higher.
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FACTORS TO WATCH * Dollar steadies after hitting lows, awaits Yellen and ADP data
* Oil steadies above $112 on supply fears * Asia shares score 3-year high on economic optimism * Foreign institutional investor flows * For closing rates of Indian ADRs
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