Background Policies to increase Australian Indigenous children’s participation in preschool aim to reduce developmental inequities between Indigenous and non-Indigenous children. This study aims to understand the benefits of preschool participation by quantifying the association between preschool participation in the year before school and developmental outcomes at age five in Indigenous and non-Indigenous children. Methods We used data from perinatal, hospital, birth registration and school enrolment records, and the Australian Early Development Census (AEDC), for 7384 Indigenous and 95 104 non-Indigenous children who started school in New South Wales, Australia in 2009/2012. Preschool in the year before school was recorded in the AEDC. The outcome was developmental vulnerability on ≥1 of five AEDC domains, including physical health, emotional maturity, social competence, language/cognitive skills and communication skills/general knowledge. Results 5051 (71%) Indigenous and 68 998 (74%) non-Indigenous children attended preschool. Among Indigenous children, 33% of preschool attenders and 44% of the home-based care group were vulnerable on ≥1 domains, compared with 17% of preschool attenders and 33% in the home-based care group among non-Indigenous children. In the whole population model, the adjusted risk difference for developmental vulnerability among preschool attenders was −7.9 percentage points (95% CI, −9.8 to −6.1) in non-Indigenous children and −2.8 percentage points (95% CI −4.8 to −0.7) in Indigenous children, compared with Indigenous children in home-based care. Conclusions Our findings suggest a likely beneficial effect of preschool participation on developmental outcomes, although the magnitude of the benefit was less among Indigenous compared with non-Indigenous children.