Puigdemont was arrested March 25 as he crossed Germany from Scandinavia on the way to Belgium, where he had fled in October after a failed effort by separatist lawmakers in his northeastern region to declare independence from Spain.
The court said that because Mr Puigdemont cannot be extradited for rebellion he posed less of a flight risk and could be released on bail.
The Higher Regional Court in Schleswig said it would not accept Spain's extradition request because the country doesn't have a comparable law.
The German judges will consider Puigdemont's extradition on the less serious charge of misusing public funds.
The court in Schleswig set bail at €75,000 for the 55-year-old to leave prison.
But he must remain in Germany while extradition proceedings continue and report to police once a week.
Responding to the ruling, a Spanish official said Mariano Rajoy's government respects judicial decisions "always, when it likes them and when it doesn't".
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He was arrested in the north German region last month, after Spain issued a European arrest warrant.
"There is a risk of flight", the court said in its explanation of its decision to grant bail.
The corruption charge is based on alleged misuse of public funds arising from his role in the disputed Catalan independence referendum.
The Spanish government's quelling of the October 1 independence referendum drew worldwide condemnation and outrage, with footage of national police officers and members of the Civil Guardia seizing ballot boxes and violently dispersing voters going viral on social media.
Two more members of the regional police and an official with the regional interior department were also indicted. Per Article 545 [text, in Spanish], sedition carries a sentence of 10-15 years in prison for people in positions of "authority".
He then came under pressure when central authorities urged the regional police to stop the October 1 referendum banned by Spanish courts.