The Spaniard, 37, returned to competition in Brisbane in January after almost a year sidelined with a hip flexor injury, but had to miss the Australian Open with another muscle tear.
He lost to Carlos Alcaraz in an exhibition event in Las Vegas on Sunday and looked poised to try to win a fourth title in the California desert.
"It is with great sadness that I have to withdraw from this amazing tournament," the 22-time grand slam champion said in a statement on Wednesday (Thursday AEDT).
"Everyone knows how much I love this place and how much I love to play here at Indian Wells.
"That's also one of the reasons why I came very early to the desert to practise and try to get ready.
"I have been working hard and practising and you all know I took a test this weekend, but I don't find myself ready to play at the highest level at such an important event.
"It is not an easy decision, it's a tough one as a matter of fact, but I can't lie to myself and lie to the thousands of fans.
"I will miss you all and I am sure the tournament will be a great success."
Nadal was scheduled to face 2016 Wimbledon runner-up Milos Raonic in the first round.
The Spaniard will be replaced by lucky loser Sumit Nagal, of India.
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