Trade Minister Warren Truss said the FTA feasibility study was a "natural extension" of the Australian government's efforts to look at ways to tap the potential of India's rise as "a major economic power."
"The study will examine the potential gains for both countries, in particular the impact a comprehensive and genuinely liberalising FTA could have on promoting economic growth, trade in goods and services, investment and other commercial linkages," he said in a statement.
India is Australia's fourth-largest merchandise export market, recording USD10.1 billion worth of exports, according to 2006-07 preliminary figures.
Truss said India was Australia's ninth largest trading partner, with two-way trade in goods reaching USD 11.4 billion in 2006-07.
"The relationship between Australia and India has been one of rapid growth in trade and investment," he said.
All states and territories, along with industry bodies and other stakeholders, will be consulted during the study.
Bilateral meetings will be held with India to discuss the study's terms of reference, with the study expected to begin by the end of the year and be completed in 2009.
The move comes just weeks after Australia announced it had struck an in-principle agreement with India to sell uSranium to the subcontinent.