Eli Yishai, the leader of Shas, told journalists after the signing of the deal: "Israel is set to face many challenges - both social and economic and on the diplomatic and security front - [and] as a result it is only right to combine forces and form a broad government."
The Shas party now joins Yisrael Beitenu, a right-wing party which takes a nationalist line on domestic and security policies.
Yisrael Beitenu signed its partnership deal with Netanyahu on March 16.
Under the agreement, Avigdor Lieberman, the party's leader, was appointed Israel's foreign minister, raising concerns that Israel's international ties will be harmed.
Lieberman has been accused of being racist because of his plans to seek loyalty oaths from Israeli Arabs wanting citizenship.
Netanyahu, who served as prime minister from 1996 to 1999, is likely to form a cabinet dominated by conservatives since both the Kadima and Labour parties have refused to join his government.
And a potential right-wing coalition could put Netanyahu on a collision course with Barack Obama, the US president, who has pledged to pursue an Israeli-Palestinian peace deal.
But Netanyahu's deputies are continuing their efforts to woo the Labor party, which agreed on Monday to open coalition talks.
Labor is set to vote on whether to join Netanyahu's government on Tuesday.
Netanyahu has until April 3 to form a cabinet.