Thursday's agreement means three telescopes built by a Tel Aviv University will be sent into space on an Indian satellite to conduct a series of experiments.
Israel hopes its Tauvex telescopes will shed light on star formation, the history of galaxies, and the physics of black holes.
The Indian satellite, known as GSAT-4, is due to launch in 2005.
However, the deal is sure to raise controversy in India where the country’s estimated 150 million Muslims are fiercely anti-Israel.
Official diplomatic communication between India and Israel began in 1992, and dealings between the two countries have grown steadily since then.
In March 2000, Jaswant Singh became the first Indian foreign minister to visit Israel.
Indian Muslims were incensed by
Ariel Sharon's recent Delhi visit
After this visit India and Israel set up a joint “anti-terror” commission and increased military cooperation. Economic ties have also strengthened considerably in recent years.
However, Indian Muslim groups fiercely condemn Israel as a state founded on the theft of land, and as a serial abuser of Palestinian and Muslim rights.
Indian Prime Minister Atal Bihari Vajpayee has tried to dispel fears in India and the Muslim world about his country’s ties with Tel Aviv.
He says the moves will not dilute India's relations with Arab states, which supply India with most of its oil.
There are also more than three million Indian expatriates in Arab countries who send remittances to their families each year, boosting the fragile domestic economy.