The story is set in Ayemenem, now part of Kottayam district in Kerala, India. The temporal setting shifts back and forth between 1969, when fraternal twins Rahel and Esthappen are seven years old, and 1993, when the twins are reunited.
Lacking sufficient dowry to marry, Ammu Ipe is desperate to escape her ill-tempered father, known as Pappachi, and her bitter, long-suffering mother, known as Mammachi. She persuades her parents to let her spend a summer with a distant aunt in Calcutta. To avoid returning to Ayemenem, she marries a man there but later discovers that he is an alcoholic, and he physically abuses her and tries to pimp her to his boss. She gives birth to Rahel and Estha, leaves her husband, and returns to Ayemenem to live with her parents and brother, Chacko. Chacko has returned to India from England after his divorce from an English woman, Margaret, and the subsequent death of Pappachi.
The multi-generational family home in Ayemenem also includes Pappachi's sister, Navomi Ipe, known as Baby Kochamma. As a young girl, Baby Kochamma fell in love with Father Mulligan, a young Irish priest who had come to Ayemenem. To get closer to him, Baby Kochamma converted to Roman Catholicism and joined a convent against her father's wishes. After a few months in the convent, she realized that her vows brought her no closer to the man she loved. Her father eventually rescued her from the convent and sent her to America. Because of her unrequited love for Father Mulligan, Baby Kochamma remained unmarried for the rest of her life, becoming deeply embittered over time. Throughout the book, she delights in the misfortune of others and constantly manipulates events to bring calamity.
|“||"It didn't matter that the story had begun, because Kathakali discovered long ago that the secret of the Great Stories is that they have no secrets. The Great Stories are the ones you have heard and want to hear again. The ones you can enter anywhere and inhabit comfortably. They don't deceive you with thrills and trick endings."||”|
|— The God of Small Things|
The death of Margaret's second husband in a car accident prompts Chacko to invite her and Sophie (Margaret's and Chacko's daughter) to spend Christmas in Ayemenem. One day on the way to a theatre , the family encounters a group of Communist protesters who surround the car and force Baby Kochamma to wave a red flag and chant a Communist slogan, thus humiliating her. Rahel thinks she sees Velutha, a servant who works for the family's pickle factory among the protesters. Later at the theater, Estha is sexually molested by the "Orangedrink Lemondrink Man," a vendor working the snack counter. Estha's experience factors into the tragic events at the heart of the narrative.
Rahel's assertion that she saw Velutha in the Communist mob causes Baby Kochamma to associate Velutha with her humiliation at the protesters' hands, and she begins to harbor a deep hatred toward him. Velutha is a dalit (lower caste in India). Rahel and Estha form an unlikely bond with Velutha and come to love him despite his caste status. It is her children's love for Velutha that causes Ammu to realize her own attraction to him, and eventually, she comes to "love by night the man her children loved by day." Ammu and Velutha begin a short-lived affair that culminates in tragedy for the family.
When her relationship with Velutha is discovered, Ammu is locked in her room and Velutha is banished. In her rage, Ammu blames the twins for her misfortune and calls them "millstones around her neck." Distraught, Rahel and Estha decide to run away. Their cousin, Sophie also joins them. During the night, as they try to reach an abandoned house across the river, their boat capsizes and Sophie drowns. When Margaret and Chacko return from a trip, they see Sophie's body laid out on the sofa.
Baby Kochamma goes to the police and accuses Velutha of being responsible for Sophie's death. A group of policemen hunt Velutha down, savagely beat him for crossing caste lines, and arrest him on the brink of death. The twins, huddling in the abandoned house, witness the horrific scene. Later, when they reveal the truth to the chief of police he is alarmed. He knows that Velutha is a Communist, and is afraid that if word gets out that the arrest and beating were wrongful, it will cause unrest among the local Communists. He threatens to hold Baby Kochamma responsible for falsely accusing Velutha. To save herself, Baby Kochamma tricks Rahel and Estha into believing that the two of them would be implicated as having murdered Sophie out of jealousy and were facing sure imprisonment for them and their Ammu. She thus convinces them to lie to the inspector that Velutha had kidnapped them and had murdered Sophie. Velutha dies of his injuries overnight.
After Sophie's funeral, Ammu goes to the police to tell the truth about her relationship with Velutha. Afraid of being exposed, Baby Kochamma convinces Chacko that Ammu and the twins were responsible for his daughter's death. Chacko kicks Ammu out of the house and forces her to send Estha to live with his father. Estha never sees Ammu again. She dies alone a few years later at the age of 31.
After a turbulent childhood and adolescence in India, Rahel gets married and goes to America. There, she divorces before returning to Ayemenem after years of working dead-end jobs. Rahel and Estha, now 31, are reunited for the first time since they were children. They had been haunted by their guilt and their grief-ridden pasts. It becomes apparent that neither twin ever found another person who understood them in the way they understand each other. Toward the end of the novel, the twins have sex. The novel comes to a close with a nostalgic recounting of Ammu and Velutha's love affair.