The Central Bureau of Investigation (CBI) on Wednesday arrested former telecoms minister Andimuthu Raja over a massive graft scam, officials said, a huge blow for Prime Minister Manmohan Singh and efforts to pass bills in the parliamentary budget session.

Raja belongs to the Dravida Munnettra Kazhagam (DMK) party, a parliamentary ally of the ruling Congress party and his arrest may spark tension between coalition partners and galvanise an opposition that has blocked parliament since November to protest the scandal over mobile phone licences.

The sale of below-market price licences, which a government audit says may have cost India up to $39 billion in lost revenues, is the biggest scandal to have hit India in decades.

A CBI spokesman told reporters that Raja was arrested due to irregularities in the allocation of mobile licences and spectrum.

The arrested would be presented before a special court on Thursday, the CBI said.

Singh, the 78-year-old prime minister who won re-election in 2009, is accused by the opposition of failing to act against Raja when complaints were raised. The scandal could overshadow Congress's campaign to win key state elections this year.

I only wish that the prime minister instead of living in denial had acted three years ago so this huge, monumental loss to the public exchequer had not taken place, Arun Jaitley, a Bharatiya Janata Party (BJP) leader, told reporters.

But the Congress party defended Singh, saying he had acted in accordance with the law of the land.

Nobody will accept that the credibility of the Prime Minster or the government has been affected, Congress spokesman Abhishek Manu Singhvi told reporters. That's absolutely wrong ... The integrity of the government is enhanced by allowing law to take its own course independently and objectively.

Raja, who was sacked in November, is accused of misuse of his ministerial office to benefit others, criminal misconduct and having unaccounted assets, local television channels reported. Raja has denied any wrongdoing.

Investigators also arrested R.K. Chandolia, Raja's personal aide, and Siddharth Behura, the former telecoms secretary during the time of the spectrum sale, television channels reported.

PARLIAMENTARY SHUTDOWN

The opposition has shut down parliament since early November, demanding a joint inquiry into the scandal, and further disruption could hit the next session of parliament in late February when the budget is due to be debated.

The government has refused to hold a joint parliamentary inquiry, fearful it could lead to senior figures like the prime minister testifying while also overshadowing both the state elections and a 2014 general election.

 The main opposition BJP repeated its demand for a full inquiry.

Financial markets have not reacted to the ongoing corruption scandal but concern has grown that the standoff in parliament has put a freeze on passing key economic reforms, such as modernising the tax system and liberalising the financial sector.

With no major parties capable of winning a majority on their own in parliament, Indian governments effectively come down to coalition-juggling. The DMK, with 18 seats, is the second biggest ally of Congress in the government.

The DMK has weakened in recent years, relying on support of other parties including Congress to hold power in Tamil Nadu. As a result, it is unlikely the DMK would pull out of the coalition, because it needs Congress as much as Congress needs it.

The world's second-fastest growing economy ranks 87th on graft watchdog Transparency International's list based on perceived corruption - a worse rating than rival China.