Zemarai Bashary, an Afghan interior ministry spokesman, said: "It was a suicide car bomb attack. There are civilian and police casualties."
One report said that two cars, one marked with UN insignia, had been badly damaged in the blast.
Smoke was seen rising from central Kabul and the windows of shops in the blast area were smashed.
Zeina Khodr, Al Jazeera's correspondent in Kabul, said: "Afghan government and intelligence sources have made clear to Al Jazeera that they believe that foreign hands were involved.
The attack has sparked speculation that Pakistan's spy agency was behind it
"This was an operation which was planned by a state and not - I quote - a group of bandits."
Sayyid Abdul Gafoor, the head of the interior ministry's anti-crime unit, said special kinds of explosives were used for the explosion and the vehicle used in the suicide attack was not registered in Afghanistan, indicating possible foreign involvement.
Vishnu Prakash, an Indian foreign ministry spokesman, said in New Delhi: "As per reports we have received, all embassy personnel are safe.
"There has been some damage to the embassy property. We are closely monitoring the situation."
The Afghan interior ministry is on the opposite side of the road from the Indian embassy.
Last July, the Indian embassy in Kabul was the scene of the deadliest single attack in Kabul of the eight-year-old war.
A Taliban suicide car bomber killed 58 people, including two senior Indian diplomats, and wounded another 141 people.
Since then, the access road to the embassy has been barricaded.
PJ Mir, a Pakistani political analyst, said Thursday's attack was an attempt to increase tensions between regional rivals India and Pakistan.
"This attack is not a target - it is meant to grab world attention," he told Al Jazeera.
"Its intention is to create terror and to create mistrust between India and Pakistan. This is purely the work of those militants who are working against the Afghan, Pakistan and Indian community at large."
After the bombing in July 2008, India said Pakistan's military spy agency, the ISI, was behind most attacks on Indians in Afghanistan as a way of undermining Indian influence.
Pakistan has long regarded Afghanistan as a fall-back position in the event of war with India.
Meanwhile, New Delhi seeks to retain influence in Afghanistan to deter anti-India groups from setting up training camps there.