Earlier this week, authorities had given manufacturers and importers 90 days to comply with the now-reversed rule.
But a government statement on Wednesday announced the decision "not to make the pre-installation mandatory for mobile manufacturers".
It added that the app "Sanchar Saathi" -- meaning communication partner in Hindi -- was "secure and purely meant to help citizens" against "bad actors".
The initial order gave rise to widespread concerns that the app might be used for surveillance, and that it could not be removed.
Communications minister Jyotiraditya Scindia told parliament on Wednesday that using the app was voluntary.
"I can delete it like any other app, as every citizen has this right in a democracy," he said.
"Snooping is not possible through the app, nor will it ever be."
The government had said the app was designed to allow users to block and track lost or stolen phones.
It also lets them identify and disconnect fake mobile subscriptions made in their name, among other functions.
Government figures show the app has already helped trace more than 2.6 million phones.
Advocacy group Internet Freedom Foundation welcomed the latest decision.
"For now, we should treat this as cautious optimism, not closure, until the formal legal direction is published and independently confirmed," the group said in a post on social media.
Hours before the government rollback, lawmakers debated the move, with opponents of Prime Minister Narendra Modi's government raising concerns over the pre-installation of the app.
"Even after the app is disabled, users will not be able to know whether all its features have been disabled or not," Deepender Singh Hooda from the Congress party said in parliament.
"In such a situation, this issue is surrounded by concerns of violation of the right to privacy and suspicions of spying."
His colleague Randeep Singh Surjewala said the app "could be a possible kill switch that can turn every cell phone into a brick, which the government could use against journalists, opposition leaders, and dissidents, if it so desires".
Surjewala also warned against the risk of hacking, which could "expose sensitive information, including passwords, bank account numbers and personal data".
In August, Russia issued a similar directive ordering manufacturers to include a new messaging platform called Max on all new phones and tablets, but rights advocates warned the app could be used as a powerful surveillance tool.
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