The move on Monday came a day after the government named an envoy to investigate the credibility of a UN report that made the allegations against Foreign Minister Natwar Singh and the governing Congress party.
Singh is among the more than 2200 companies and prominent politicians worldwide accused in the UN report of colluding with Saddam Hussein's government to bilk the humanitarian oil-for-food programme of $1.8 billion in kickbacks and illicit surcharges.
The Indian judicial investigation will be led by RS Pathak, a former chief justice of India who is also a former judge of the International Court of Justice, according Prime Minister Manmohan Singh's spokesman, Sanjaya Baru.
Baru said Pathak will "head the inquiry into matters relating to the report of the Independent Inquiry Committee", which had made the allegations about corruption in the oil-for-food programme.
Volcker's report has exposed the
ruling Indian party to criticism
"The scope of the inquiry and terms of reference will be announced shortly," he said, without elaborating.
No time-frame has been set for the investigation.
He denied that the move was aimed at deflecting pressure from Natwar Singh, who is facing opposition calls for resignation.
"A former chief justice doesn't do cover-ups," he said.
The independent UN investigation, led by former US Federal Reserve Chairman Paul Volcker, has become a major embarrassment for Singh, a 74-year-old former diplomat who has led India's campaign for a permanent seat on the UN
Volcker's report named Singh and the Congress party as a "non-contractual beneficiary."
The Indian government has treated the report sceptically but said it will do everything to get to the bottom of the controversy.
A defiant Singh has rejected calls for his resignation, insisting that he received no favours or bribes from Saddam's government, or benefited from the oil-for-food