Naama Issachar, 26, was detained in Moscow in April 2019 after more than nine grams of marijuana were found in her luggage.
She was later sentenced to more than seven years in prison.
Israeli Prime Minister Benjamin Netanyahu thanked his "friend" Mr Putin for the decision to pardon Issachar.
President Reuven Rivlin also expressed his gratitude to the Russian leader "for the wisdom and mercy of the decision".
Israeli media have reported that the Israeli government was willing to relinquish ownership of a complex in Jerusalem - symbolic to the Russian Orthodox Church - as a goodwill gesture ahead of Issachar's release.
Ownership of the Alexander Courtyard, which lies in Jerusalem's Old City near the Church of the Holy Sepulchre, has been disputed for decades, but an Israeli court recently ruled in Russia's favour.
Naama Issachar was returning from a trip to India when she was detained.
Her case gained widespread attention in Israel, with local media accusing Moscow of using it to pressure Israel over a jailed Russian hacker, whose extradition was requested by both the US and Russian governments.
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