I am going to keep my answer limited to the discussion only about the 'withdrawal of the emergency'.
(If you want to know about why was it imposed, you can read Alok Pandey's answer to Politics of India: What were the reasons Indira Gandhi imposed Emergency in 1975?)
Now we all know how authoritarian and dictatorian India Gandhi went during the emrgency.India’s strength has always been its vibrant democracy. Ours is perhaps the only country where people from contrastingly different castes, creed, religion and race live together in peace and harmony. The other hallmarks of our country are a strong judicial system and a free press. The imposition of the emergency in 1975 struck at the very core of these ideals, which constitute our democracy. It was perhaps the darkest period in the history of independent India.
Now, the common mistake people do when they ask this question you aksed is the mis-fact they know that 1977 elections were held after the emergency was called off. No, the emrgency was still in effect then.
Conscious of her world image..
In the world she was being described as a dictator and she wanted to prove she wasn't.
According to Amnesty International, 140,000 people had been arrested without trial during the twenty months of Gandhi's Emergency. Jasjit Singh Grewal estimates that 40,000 of came from India's two percent Sikh minority.
The Economist, London, described the resistance movement against the Indira regime as "the only non-left revolutionary force in the world". It said that the movement was "dominated by tens of thousands of RSS cadres, though more and more young recruits are coming". Talking about its objectives it said "its platform at the moment has only one plank: to bring democracy back to India".
The Plan
Her own department did a survey and told her if she held the election during the Emergency she would return to power.Also Indira Gandhi believed that the opposition was splintered and that elections would only accentuate the divide among them. And by winning the elections she could legitimise the Emergency and all that happened as part of it before the international community and also formalise Sanjay Gandhi's position.
That, perhaps was the reason why she chose to announce the dissolution of the Lok Sabha on January 18, 1977 and the release of all political prisoners. More specifically she did that unilaterally, in the same way as when the Emergency was proclaimed.Indira Gandhi called for fresh elections .
It was a courageous decision, considering the fact that she was under no visible compulsion to do so.
But..
March 21, 1977, was indeed an important day in the history of independent India. The last of the results to the general elections, held during the previous week, were out quite early in the morning that day. And Indira Gandhi, her son Sanjay Gandhi, V.C. Shukla, Bansi Lal, Pranab Mukherjee, Om Mehta and such others who had presided over the semifascist Emergency regime had lost the elections.
The 'plan' was miscalculated and had backfired. The people played their historic role and threw her government out even though the Emergency still existed.
Ouchhh!! Burn!!
The voters in Rae Bareili, a constituency that was rural in most parts, rejected Indira Gandhi in the most emphatic manner. Indira Gandhi had lost from Rae Bareli by a margin of 55,202 votes!
And Sanjay Gandhi, who tried his luck from neighbouring Amethi too was humbled by Ravindra P Singh, a political novice. The margin of victory in Amethi was 75,844 votes.
The Congress party was swept aside everywhere in the North. And all of Indira Gandhi's men were defeated.
Indira Gandhi's Congress party drew a blank from Bihar (with 54 Lok Sabha seats), Himachal Pradesh (with 4 seats), Punjab (with 13 seats) Uttar Pradesh (with 85 seats) and Delhi (with 7 seats). The party won just one seat each in Haryana (out of the 10), Madhya Pradesh (out of 40) and Rajasthan (out of 25). In West Bengal, the Congress won just 3 out of the 42 Lok Sabha constituencies, 4 out of the 21 seats from Orissa, 10 seats out of the 25 from Gujarat and 20 out of the 48 from Maharashtra. In all, the Congress strength in the Lok Sabha stood at 154 (in the House of 542), the lowest in the party's history till then. It is another matter that, interestingly, this is higher than the Congress party's strength after May 2004! :P
Now the twist..
Ever heard of Bhasmasur? :D
See Indira Gandhi government in 1971, enacted a controversial law, Maintenance of Internal Security Act, giving the administration of Prime Minister Indira Gandhi and Indian law enforcement agencies super powers - indefinite "preventive" detention of individuals, search and seizure of property without warrants, and wiretapping - in the quelling of civil and political disorder in India, as well as countering foreign-inspired sabotage, terrorism, subterfuge and threats to national security, the one which was exploitatively used by her regime during the emergency to curb the opposition.
Now that the political winds had changed and the opposition was in power with landslide majority and the emergency was still in effect, technically she found herself and her allies on the receiving end and hence, how do I say it politely, was the one in deep shit.
She obviously couldn't change the law overnight, right? So what did she do. She called off the emergency and resigned the next evening on on March 22, 1977.
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