Prime Minister Manmohan Singh will hold additional charge as finance minister.
Chidambaram replaces Shivraj Patil, who resigned on Sunday, owning up responsibility for the Mumbai terror attacks.
Congress sources said Chidambaram is a man who can plan strategy and execute it in time of crisis. A Congress source told ,"We understand that India has the sympathy of the people and governments all over world."
Chidambaram was minister of state for internal security in the Rajiv Gandhi government, at the height of the Punjab crisis.
Dr Singh was finance minister in the P V Narasimha Rao government.