The government has accepted his resignation with immediate effect, a defence ministry release said.
Meanwhile, Vice Admiral Robin Dhowan will take over as Acting Naval Chief till regular Chief is appointed.
Smoke engulfed Russian-made submarine INS Sindhuratna off the Mumbai coast, causing serious illness to seven sailors and leaving two officers missing.
Vice Admiral Robin Dhowan will take over as Acting Naval Chief.
The seven sailors had to be airlifted to a hospital after they inhaled smoke.
An upset Defence Ministry sought a detailed report from the Navy on the mishap, which is the 10th involving an Indian Navy warship and the third submarine mishap in the last seven month after the sinking of INS Sindhurakshak in August in which all 18 personnel on board were killed.
"Indian Naval Submarine Sindhuratna was at sea off Mumbai for routine training and workup (inspection). While at sea in the early hours of today, smoke was reported in the sailors accommodation, in compartment number three, by the submarine," the Navy said in a press release.
Western Command's Commodore Commanding Submarine (COMCOS) Commodore S R Kapoor was on board the vessel carrying out an inspection before it was to be cleared for operational duties, Navy officials said.
"We immediately activated our emergency firefighting exercise and seven personnel who had inhaled smoke were airlifted to a hospital. Two officials are unaccounted for. They might have been left in the cabin or at some other place as various cabins and compartments are isolated as part of the emergency measures," the officers said.
The injured has been admitted to the naval hospital INS Ashwini after they were airlifted by Seaking multirole helicopters in multiple sorties.
As many as 70-odd officers and men were on board at the time of the mishap but no weapon systems were fitted on it.
The submarine, which did not suffer much damage, was underwater when the mishap occurred and was later brought to the surface.
Sindhuratna had recently undergone a refit in Mumbai and was handed over to Navy in December.
It was to undergo two exercises, one at harbour and another at sea, before it was to be given operational clearance.
It was at 'Task 2 (exercise at sea)' when the mishap occurred. The release said all other crew of the submarine are on board and safe.
"Submarine is also safe and this does not have any weapons on board. The submarine will return to harbour shortly," it said adding that an inquiry has been ordered to establish the cause of the incident.
Reflecting the gravity of the mishap, Defence Minister A K Antony briefed President Pranab Mukherjee, who is also the Supreme Commander of Armed Forces, and Prime Minister Manmohan Singh on the accident.
Around a month ago, INS Sindhughosh had a close shave when it entered the Mumbai harbour during a low-tide phase and was about to run aground.
INS Sindhurakshak sank in the Mumbai harbour last year, killing all 18 personnel on board. Defence Minister AK Antony has sought a detailed report from the Navy on the issue.
Earlier this month, INS Airavat, an amphibious warfare vessel, ran aground after which the commanding officer was stripped of his command duties.
After the sinking of the INS Sindhurakshak, one of the mishaps involved INS Betwa which was damaged after probably hitting some underwater object.
India's leading minesweeper, the INS Konkan that was undergoing repairs in Vizag, also caught fire and suffered major damage to its interiors.
The Pondicherry-class minesweeper was getting a refit at a dry dock when the incident occurred.
The naval headquarters is concerned over the spate of mishaps in the Western Command and had even summoned Western Naval Commander Vice Admiral Shekhar Sinha on the issue.
The Western Command headquarters was damaged when Naval Armament Depot personnel misfired a heavy-calibre gun at it while checking it.
(With PTI inputs)