The road transport ministry said in a statement it will assign a rating of one to five stars for cars, based on tests assessing adult and child occupant protection as well as safety assist technologies.
The new system is slated to come into effect in April 2023.
India, which has some of the world's deadliest roads, has also proposed mandating that all passenger cars have six air bags, despite resistance from some carmakers which say it will increase the cost of vehicles. Current rules call for two airbags - one for the driver and one for the front passenger.
India is the world's fifth-largest car market, with annual sales of around 3 million units a year. Maruti Suzuki, majority owned by Japan's Suzuki Motor, and Hyundai Motor are the biggest-selling automakers.
(Reporting by Munsif Vengattil and Aditi Shah in New Delhi; Editing by Edwina Gibbs)