The announcement comes amid sustained protests over last month´s alleged rape and murder of two local Muslim women by members of the Indian security forces.
Home Minister P. Chidambaran told a news conference in Srinagar, where he has been conducting an urgent review of the security situation, that the army should carry out counter-insurgency operations "far away from towns and cities."
"In the inhabited areas we believe maintaining law and order is the primary responsibility of the state police," he told reporters.
He did not give a timetable for the redeployment of troops, but said: "It will take some time. That is the direction in which we have agreed to move and we will move.
"In extremely difficult conditions, if the army is called in for help, the army will render help," he said, but added that the army should now focus its efforts on patrolling the Line of Control, which divides Kashmir between India and Pakistan.
The redeployment of troops, he said, was being done because militant violence inside Kashmir had dropped, but insurgent infiltrations along the Line of Control were continuing.
The anti-India insurgency in the region has left more than 47,000 people dead by official count since it started in 1989.
The level of violence has dropped since India and Pakistan started a peace process in 2004 to resolve all their pending disputes, including Kashmir.
The presence of Indian troops across Kashmir, especially in the Muslim-dominated Kashmir valley, has long been a major source of tension in the region.
For the past two decades, Indian troops have regularly been accused of human rights violations including rapes, murders and the torture of suspected militants.
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