Prime Minister Manmohan Singh failed to break an impasse on Tuesday, with opposition parties and his own political allies demanding a rollback of a reform allowing foreign supermarket giants to enter the country's $450 billion market.
The deadlock means Singh's Congress party-led coalition faces further opposition disruption of parliament, which has been adjourned for six days already, threatening other major bills, such as one on food subsidies for the poor.
The reform, which would allow global chains like Wal-Mart Stores Inc and Carrefour to own up to 51 percent of retail ventures, remains in limbo as talks between the government and political parties failed to make any breakthrough.
With a slender parliamentary majority, the government is dependent on its allies, but does not face any immediate threat of losing power.
Singh has several options. He could reverse his cabinet's decision - an unlikely move given it would be a major political set-back and damage India's image with sorely needed foreign investors just as Asia's third-largest economy is showing signs of slowing.
A more likely move would be to postpone the reform. The Hindu newspaper, quoting unnamed government sources, said the prime minister could refer the reform to a group of ministers, a traditional way of Congress kicking problems into the grass. Or the government could just ignore the opposition and move ahead, risking political uproar.
We are willing to discuss whatever the opposition wants, but they should allow the House to function, said Rajiv Shukla, junior parliamentary affairs minister.
Sonia Gandhi, the Congress party head, who runs the government from behind the scenes, appeared to have been behind a move to water down the new rules and insist that foreign retailers source more goods from small Indian businesses.
That swift reversal showed how Singh's cabinet, many of them in their seventies, could be out of synch with Congress - the latest sign of how Gandhi and her small team of loyal advisers can put politics first to water down reforms. But the policy tweak did little to placate opponents.
The government has implemented the policy of FDI in retail after lobbying of companies in the U.S. and other countries. We are totally against this, Murli Manohar Joshi, a leader of the Bharatiya Janata Party, said after the meeting. A government ally, the Trinamool Congress party, which gives Congress a parliamentary majority, also wants a policy reversal.
The controversy comes at a bad time for Congress, worried the issue could become a lightning rod for criticism of the government before state elections due next year.
The issue feeds into some deep-seated nationalism of Indian politicians, as well as fears of massive job losses among the millions of small shopkeepers.
Indian shares were subdued on Tuesday as economic concerns came to the fore, and mounting political opposition to reforms unnerved investors.
Kaushik Basu, one of Singh's close advisers, said allowing global chains to open their first stores in India would be one of the most effective ways to help the country deal with food inflation, which stands close to 10 percent.
The economy, which grew at 8.5 percent in 2010/11, is widely expected to grow at around 7 percent this year, slowed by policy paralysis and a gloomy global outlook.