China in February said its airlines were barred from participating in the scheme unless they get government approval to do so. Beijing has also suspended the purchase of $14 billion worth of planes for Europe's Airbus due to the dispute.

India does not yet plan to ask airlines to cancel Airbus purchases, but that is a possibility if the dispute escalates, the Indian official said.

The official, with direct knowledge of talks between the EU and other countries on the issue, told Reuters that India would soon ask local airlines not to share emissions data with the bloc or buy any carbon credits.

If the European Commission retaliated by suspending Indian airlines from flying to Europe, India would make 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 questions is, 'Are you (the EU) provoking the world into a trade war?" the official said.

FAST-GROWING MARKET

Amber Dubey, director for aviation at global consultancy KPMG, said India was in the midst of a huge increase in the size of both its civilian and defense fleets, 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, making fast-growing India a crucial growth market.

Foreign governments 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.

The EU scheme has been widely criticized by the aviation industry, and on Tuesday Indonesia's state-owned airline Garuda said it might stop flying to Amsterdam in response.

"If (the regulation) is too costly, we could be forced to close our European routes," President Director Emirsyah Satar told Reuters.

Thai Airways 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."

DISRUPTIVE DISPUTE

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 may 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."

The European Commission has said it introduced a carbon cost for all flights, because well over a decade of talks at the United Nations' International Civil Aviation Organization (ICAO) had failed to agree on a way to curb the sector's rising emissions.

The escalation of international tension over the EU's scheme has accelerated efforts at the ICAO to come up with a global plan. At a meeting last week, it directed a working group to continue studying the options and report back in June.

The European Commission has said it will modify its law if the ICAO can deliver a convincing alternative and is doing its best to help.

"The EU is working hard to achieve a global agreement. The sooner the better. And it is really encouraging how strongly the ICAO Secretariat tries to move things forward," Climate Commissioner Connie Hedegaard said in an emailed comment. ($1 = 30.7250 Thai baht)

(Additional reporting by Barbara Lewis in Brussels, Reza Thaher in Jakarta and Ploy Ten Kate and Manunphattr Dhanananphorn in Bangkok; Editing by Tony Munroe, Alex Richardson and Jonathan Hopfner)

• A Permanent Economic Emergency