Islamic law imposes restrictions on investing in companies that charge interest and those that sell products such as alcohol, weapons or tobacco.
The index, called BSE TASIS Shariah 50, is composed of the 50 largest and most liquid stocks that adhere to Islamic law. The companies were chosen by the Taqwaa Advisory and Shariah Investment Solutions (TASIS), a Mumbai-based Islamic finance firm whose board members include legal experts and Islamic scholars.
Stocks will be reviewed monthly for Shariah compliance, and non-compliant stocks will be removed. Additional companies will be added on a quarterly basis.
"It will create a market for Indian Muslims," Shariq Nisar, the director of research and operations at TASIS, said in a statement. "We can provide opportunity to domestic investors so that they can invest their money without falling foul of their ethical and religious requirement.
"A lot of Muslim investors who could have invested their money in stock market and benefited from it, they were not having this opportunity earlier."
Islamic indexes already exist in other countries in the Middle East and Asia, including Pakistan and Indonesia, which have the two largest Muslim populations in the world. (India is third, with more than 150 million Muslims, or 13 percent of its predominantly Hindu population).
The other countries' financial systems are not necessarily sophisticated enough to support large stock indexes.
India's development in the past decade, however, allows it to support such a large index, which started Monday. "The BSE has the largest number of listed Shariah-compliant stocks in the world," Nisar said. "All Muslim countries of the Middle East and Pakistan put together do not have as many listed Shariah-compliant stocks as are available on the BSE."
The index is expected to encourage members of India's newly emerging Muslim middle class to invest, instead of saving money because of their conservative values.
"These people were just keeping the money under their pillows," Nisar said. "Many were investing either in gold or in real estate."
The index will make it easier for Muslims to know which companies adhere to Shariah law, encouraging Muslims on a psychological level to invest.
The new index will increase awareness of "financial investments amongst the masses and help enhance financial inclusion," Madhu Kannan, the managing director and chief executive of the BSE, said in a statement.
Muslims, many of whom have been excluded from India's financial sector in the past because of Islamic law, will now be able to invest guilt-free.