Thousands of people have gathered on the Janaki temple premises to welcome Mr. Modi.
"Mere Bhai, this welcome is an honour to all Indian citizens", Modi said.
The two leaders also laid the foundation stone of Arun-III, a hydropower project in Kathmandu. The treaty was signed in the year 1999 to ease Nepal trading with the third world countries.
He said these high-level and regular interactions reflect his government's commitment to the "Neighbourhood First" policy, in consonance with the motto of "Sabka Saath, Sabka Vikas".
Ahead of Modi's visit, Nepal's Energy Minister Barsha Man Pun on Tuesday announced that the government would invite global bids for building the Budhi Gandaki project.
Modi plans to visit two more important Hindu temples before flying home on Saturday.
Analysts say it is meant to counter China's influence with Nepal.
Many in Nepal remain suspicious of India's "big brother" attitude, and the hashtags #ModiNotWelcomeInNepal and #BlockadeWasACrimeMrModi trended on Twitter as the Indian premier touched down. A team of India experts will also conduct a feasibility survey for inland water navigation from Nepal to India. "Without Nepal, India's faith, belief and history are incomplete". It is a memorable experience for me to visit this pilgrimage site which holds special place in the hearts of people of India and Nepal.
"Nepal and India relations were started during the rule of King Janak in Treta Yuga and the bondage built by Sita during the period is still strong". The army also offered him a 21-gun salute. On behalf of all Indians, I wish for the peace, progress and prosperity in the lives of people of Janakpur and Nepal.
"People of India and Nepal are bound by mutual respect and admiration for each other", the prime minister said.
The Prime Minister flagged off the bus service after offering prayers at the Janaki temple, dedicated it to Hindu goddess Sita. Modi will spend around 45 minutes in the temple.
Earlier, Defence Minister Ishwar Pokhrel and Province 2 Chief Minister Lalbabu Raut received Mr. Modi at the airport. He also talked about the importance of social change, and the popularity of Nepali language in India.
Indian Premier Narendra Modi is due in Nepal on Friday for a two-day visit created to mend fences with its smaller neighbor, but anger is still simmering in the landlocked country over a crippling blockade some two years ago.