A senior Indian government official told Reuters that India would soon ask local airlines not to buy carbon credits from or share emissions data with the bloc, which says other countries are not doing enough to tackle this source of greenhouse gases.
China said in February its airlines were barred from participating in the EU Emissions Trading Scheme (ETS) unless they got government approval. Beijing has also suspended the purchase of $14 billion worth of jets from European maker Airbus (>> EADS).
India does not yet plan to ask airlines to cancel Airbus purchases, but that is possible if the dispute escalates, said the Indian official, who has direct knowledge of talks between the EU and other countries on the issue.
If the European Commission then stopped Indian airlines from flying to Europe, India would retaliate with similar moves and consider charging an "unreasonable" amount for flying over India, the official said on Monday.
"We have lots of measures to take if the EU does not go back on its demands. We have the power of the economy; we are not bleeding as they are," the government official said, adding that Europe's position would harm its own economy and airlines.
The Indian government is awaiting formal approval from several ministries to implement the order to airlines, which it expects soon, the official said.
"The question is, 'Are you (the EU) provoking the world into a trade war?'," the official said.
The European Commission's climate spokesman Isaac Valero-Ladron said: "We will modify our legislation when there's an ambitious global agreement in force."
The EU law obliging all airlines to buy carbon permits to offset their emissions took effect from January 1, but no-one will receive a bill until April next year, after the amount of emissions has been calculated.
That leaves plenty of time for sabre rattling.
China, Russia and the United States have already issued a series of threats.
The United States said last year that it would take "appropriate action" unless the EU reconsidered, though its proposed blocking legislation stops short of making it illegal to comply with the EU legislation.
The U.N.'s International Civil Aviation Organization (ICAO) has accelerated efforts to find a solution, but is still not expected to deliver anything before the end of this year.
It held talks in Canada last week and only agreed to keep studying the options.
Outside the official ICAO forum, a so-called coalition of the unwilling has held a series of meetings to debate ways of opposing the ETS, but have not come to firm decisions on implementing them.
The financial cost of the EU's scheme is small - around 2 euros per passenger for a flight from Beijing to Frankfurt, for instance - and those who support it see it as a valuable catalyst to action elsewhere.
"Aviation's entry into the ETS has prompted ICAO to set itself a deadline to come forward with a global scheme by the year's end," said Jos Dings, director at T&E, a non-government campaign group focused on transport and the environment.
"Almost 15 years after the Kyoto protocol assigned responsibility for dealing with aviation's climate impact to ICAO, there is finally a sense of urgency."
The Intergovernmental Panel on Climate Change estimated that aviation accounted for about 2 percent of greenhouse gas emissions in 1999, and that had been rising about 9 percent a year since 1960.
The European Commission has said it will modify its law if the ICAO can deliver a convincing alternative and is working towards a global agreement.
Tony Tyler, head of the International Air Travel Association, said the last thing the industry wanted was a trade war, but Europe needed to give some ground.
"They're going to have to show some willingness to make concessions, otherwise it's not a negotiation ... What we've seen in recent weeks is a hardening of attitudes around the world on this issue," he said.
While aviation bosses have protested to the European Commission, a group of Nobel prize-winning economists wrote to U.S. President Barack Obama urging him to drop opposition to charging airlines for carbon costs.
FREE TRADE AGREEMENT
India's opposition to the ETS could put paid to the chances of the Free Trade Agreement (FTA) it is currently negotiating with the EU. Differences over duties on cars and market access for software and services companies were already standing in the way of an accord.
"It would probably be extremely difficult, if not impossible to get the FTA through the (European) parliament if India does this (ignored EU ETS aviation law), and India is in the last stage of this negotiation," said former European lawmaker Glyn Ford, who now works at Brussels-based consultancy GPlus.
Amber Dubey, director for aviation at global consultancy KPMG, said India was in the middle of a huge increase in its fleets of both civilian and defense planes, with a significant share of the orders coming from European suppliers.
"The EU-ETS issue is escalating fears of a trade war between the EU and the rest of the world. There is a chance that the government may decide to use these large aircraft orders as a negotiating tool," Dubey said.
European planemaker Airbus has a 73 percent share of the commercial plane market in India. It has orders for more than 250 planes with IndiGo, Go Air and Kingfisher Airlines (>> Kingfisher Airlines Ltd), making India a crucial growth market.
Foreign governments including the world's top three carbon emitters, the United States, China and India, say the EU is exceeding its legal jurisdiction by charging for an entire flight, as opposed to just the part covering European airspace.
But Europe's highest court ruled in December that the EU law did not breach international agreements.
Thai Airways (>> Thai Airways International PCL) President Piyasvasti Amranand said the state-controlled airline also opposed the EU law, but declined to comment on its impact on plane purchases.
"If nothing changes, this will cost us 200-300 million baht ($6.5-$9.75 million) a year starting 2013," Piyasvasti said.
"I do agree with the idea of reducing carbon emissions, but the way EU has come up with the calculation for making airlines pay is something we feel is unfair."
India this month inadvertently delayed approval of some European summer schedules by a day, which disrupted the flight schedules of many European airlines.
The official said India might use that example to show how disruptive a dispute with the country could be.
"If things continue like this, then European airlines will be forced to avoid flying over India and go over the Indian Ocean and the Bay of Bengal," the official said. "That's not viable for them. They won't have fuel to do that."
($1 = 30.7250 Thai baht)
(This March 20 story from New Delhi has been corrected to remove reference to Garuda and quote from president director in paragraphs 32 and 33 because the accuracy of the quote could not be verified)
(Additional reporting by Barbara Lewis in Brussels and Ploy Ten Kate and Manunphattr Dhanananphorn in Bangkok; Editing by Will Waterman)
By Anurag Kotoky