Ikea last month asked India for permission to launch retail operations in India, promising to invest $1.9 billion over the coming years -- part of a broader push into emerging markets including China and Russia.
Ikea's request gave a vital boost to India's government which hailed it as a sign that global investor confidence "is still intact" despite a sharply slowing economy, a slew of corruption scandals and suffocating red tape.
But now New Delhi's insistence that the world's biggest furniture retailer source 30 percent of its supplies from small Indian manufacturers has become a sticking point.
India defines a small business as any firm whose plant investment does not exceed $1 million. But Ikea says small firms would fast outgrow the cap after they started supplying the Swedish giant and become much bigger players.
"Small industries need to be allowed to grow and develop," Ikea spokeswoman Josefin Thorell told AFP by email late last week, adding it was important that the definition of small industry provide "flexibility".
IKEA says suppliers should continue to qualify as small businesses even after they exceed the investment ceiling.
It has also asked that its compliance with the sourcing target be calculated over a 10-year span rather than one year, saying it would be "impossible for the Ikea Group to meet this requirement from day one".
India's media at the weekend reported government divisions over Ikea's bid for relaxation of the sourcing rules that critics say discourage overseas investment.
The sourcing stipulation is part of efforts by the centre-left government to defuse populist opposition to the entry of big foreign retailers in a country where small mom-and-pop stores dominate as well as to boost local industry.
India's Business Standard newspaper said the government body responsible for industrial development had agreed to tweak the rules to suit Ikea.
But the Times of India said the small business ministry opposed any dilution of the regulations on grounds it would hurt small enterprises.
Given Ikea's high-profile and Prime Minister Manmohan Singh's statement on Friday that he wants to make the country a "more business-friendly place", most analysts believe a compromise will be found.
Ikea, which in 2009 scrapped plans to enter the market due to regulatory concerns, says it has a "long-term vision" for India.
"Keeping in mind Ikea's stature, I'm sure the government will work out something," Saloni Nangia, president of retail consultancy Technopak, told AFP.
"Meeting the 30 percent sourcing target will take time -- Ikea just wants some latitude," she added.
Privately-held Ikea says it is "eager" to open stores in the country of 1.2 billion people but has set no target date.
It made its investment announcement after India allowed foreign retailers selling one brand to own 100 percent of their Indian businesses, instead of 51 percent, as part of moves to liberalise the sector.
Ikea sees huge potential in India's burgeoning middle class whose "wallet is still thin" but who want "inexpensive but nice home furnishings", Ikea chief executive Mikael Ohlsson told AFP on a scouting mission to India two years ago.
"It will be good for Ikea to have such a large market. Even with the economy slowing, the retail market has a strong future," said Technopak's Nangia.
Technopak estimates the retail market is generating sales of $470 billion a year -- of which only $27 billion comes from "organised retail" or chain stores.
Retail sales are seen hitting $675 billion over the next five years -- out of which $85 billion will come from chain stores.