The decision follows hectic discussions which went on for nearly a week between Mr Chandy, Mr Chennithala, senior leader AK Antony and representatives of the party's high command - the Congress president's political secretary, Ahmed Patel, and the AICC General Secretary (in-charge of Kerala) Mukul Wasnik.
Mr Chennithala, who has been at the helm of the party in Kerala for the last eight years, had made made it clear he was not keen on joining the state government as a minister.
However, Mr Chandy wanted the PCC chief's entry into his Cabinet to give a breather to his government.
"Today, I am very happy that the Congress president approved my position and gave the consent for me to continue as PCC president and not join the government. I will work for the party in the ensuing Lok Sabha polls and I will try my level best to get more seats in the state," Mr Chennithala said after his meeting with Mrs Gandhi.
He met the party president hours after Mr Chandy had held discussions with her separately.
"When the new government was formed under the leadership of Chandy, I was very reluctant to join it. I'd categorically stated that I was not interested in joining the government," the PCC chief said.
Mr Chennithala, who has been asked to stay back in Delhi by the party high command, is learnt to have toughened his stand after two major allies of the Congress in the state - Indian Union Muslim League and Kerala Congress (Mani) - expressed reservations over his induction as Deputy Chief Minister.
The two alliance members had often stated that as key partners, they too had a claim to the slot, which is now non-existent.
"I'm a staunch Congress loyalist. I will not compromise with my party's interest for a ministerial berth... But I am pained, because my name has been unnecessarily dragged into a controversy. I feel that was unnecessary. It was unwarranted," Mr Chennithala said.