The government had been battling the Opposition in Parliament over the reform decision but West Bengal chief Minister Mamata Banerjee punctured any plan it had. The government was likely to release an official statement regarding the issue on Monday.
Analysts and business leaders slammed the Congress party for potentially bungling a crucial policy change that has been a decade in the making, and bemoaned the weak leadership of Prime Minister Manmohan Singh in the face of a parliamentary revolt.
"It makes the position of Manmohan Singh even more weak. Clearly the man carries no authority," said Arvind Singhal, founder of Technopak Advisors, a New Delhi-based consulting company.
He said India's lack of leadership was eroding much-needed investment, from domestic businesses as well as foreign. "The impact on investors will be very negative in terms of confidence," he said. "We need FDI, but India needs significantly more investment from within."
Opposition to the measure was "to the detriment of the vast majority," wrote Ashok Ganguly, former chairman of Hindustan Unilever and Deepak Parekh, chairman of Housing Development Finance Corp, in an open letter described as "a call to the saner sections of Corporate India to come out and strongly support progressive measures."
Shares in Pantaloon, whose Big Bazaar supermarket chain is seen by sector analysts as the number one tie-up target for a foreign supermarket, fell as much as 11% in early trade on Monday.
Shares in Shopper's Stop dropped over 9 percent, while Trent, the retail arm of the Tata Group conglomerate which already has an association with UK giant Tesco, saw its stock slide as much as 4%.
The reform, as it was first presented, would allow global chains like Wal-Mart, Tesco Plc and Carrefour into the chaotic retail sector, and is seen improving supply-chains and cold-storage, and helping to tackle stubbornly-high inflation.