Kejriwal's release is expected to boost the morale of his decade-old Aam Aadmi Party (AAP) as it will allow him to campaign in regional elections next month in the northern state of Haryana, where AAP is trying to make inroads, and in Delhi early next year.

Kejriwal was first taken into custody in March by India's financial crime-fighting agency, weeks before the country's national elections, in relation to alleged irregularities in the capital city's liquor policy.

Although he was granted bail in that case in July, he remained in detention due to his arrest a month previously by the federal police in a graft case related to the same policy.

Kejriwal, 55, and AAP deny the allegations and say the cases are "politically motivated".

Ordering Kejriwal's release, Justice Surya Kant said that the issue related to "liberty" and "prolonged incarceration" could not be justified.

The two-judge bench was split, however, on Kejriwal's appeal challenging his arrest, with Kant holding it lawful while Justice Ujjal Bhuyan said the timing raised serious questions.

The federal police "must not only be above board but must also be seen to remain so ... in a functional democracy governed by the rule of law, perception matters," Bhuyan said.

In its first reaction following the verdict, AAP said, "Truth can be troubled, but not defeated".

Opposition parties have been demanding Kejriwal's release, saying his arrest was an attempt by Prime Minister Narendra Modi's Bharatiya Janata Party (BJP) to deny them a level playing field in the polls, charges denied by Modi and BJP.