MSCI will include 222 large capitalization Chinese stocks in its MSCI Emerging Markets Index, representing 0.73 percent of the index.
MSCI's decision has been closely-watched as a sign of China's growing importance on international financial markets.
MSCI said the move has "broad support" from international institutional investors and was the result of loosening of restrictions enacted by China on foreign ownership of "A" shares -- stock in mainland China-based companies -- ownership of which had once been limited to mainland citizens.
"International investors have embraced the positive changes in the accessibility of the China A shares market over the last few years and now all conditions are set for MSCI to proceed with the first step of the inclusion," said Remy Briand, MSCI managing director.
"MSCI is very hopeful that the momentum of positive change witnessed in China over the past years will continue to accelerate."
MSCI says its emerging markets index is tracked by more than $1.5 trillion in assets. The company said the Chinese representation in the index could be increased in time if China enacts additional reforms.
MSCI has in the past cited obstacles such as China's restrictions on market access and on moving capital in and out of the country. Prior to Tuesday's decision, it had excluded Chinese shares for three years in a row.
"We reflected the comments from the institutional investor community. They (Chinese officials) took them very seriously and acted upon some of them," MSCI chief executive Henry Fernandez told CNBC.
Institutional investors praised a decrease in the number of stock suspensions in China, but said the current level is still an "outlier" compared with other markets, MSCI said.
Chinese shares will go into a number of provisional indices before they are included in the flagship index starting in June 2018.
China's inclusion would help around $8 billion flow into its stock markets, Capital Economics said, describing it as "a token inclusion" given that the weighting would be the equivalent of 0.1 percent of the domestic market's capitalization.
Analysts nevertheless said China's admission to the index would be a good start.
"A low number of shares and weighting is not important at the beginning," said Li Daxiao, chief economist at Yingda Securities.
"It is like opening a door. Even if it is just a crack, it is a huge improvement compared to being completely shut."
Citic Securities analyst Zhang Qun said inclusion would have "more of an emotional effect than a practical one".
"It is the change from zero to one. If in the next few years the degree of opening up increases... then it could go from one to 10 or even 100," Zhang said.
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