India put on hold a $750 million deal to buy helicopters from Finmeccanica SpA after the arrest of the head of the Italian defence group, as political opponents tried to capitalise on the latest scandal to hit the government before elections next year.
"India decides to put on hold the delivery of helicopters," one of the sources said, adding that the suspension would hold until the CBI completed its enquiry. When asked about payment, the official said: "Payment as well."
The second source confirmed that the decision to suspend the deal had been taken.
India's most watched English-language news channel, Times Now, later ran its own report saying Defence Minister A.K. Antony had confirmed that the deal was suspended.
Finmeccanica shares(SIFI.MI) were briefly suspended from trade in Milan after falling more than 5 percent on the reports from India before recovering slightly to close down 4 percent at 4.23 euros.
Italian police arrested Finmeccanica's chief executive Giuseppe Orsi on Tuesday for for allegedly paying bribes to secure the sale of 12 AgustaWestland executive helicopters to the Indian Air Force when he was head of the Finmeccanica helicopter unit. The first three helicopters have already been delivered. Orsi's lawyer denied the allegations.
The conglomerate, 32 percent owned by the Italian state, was due to hold a board meeting on Wednesday afternoon to broaden the powers of its long-standing chief operating officer to stand in for Orsi, a source familiar with the situation said.
The company promised a statement later on Wednesday.
HISTORY OF CORRUPTION
India, the world's largest weapons importer, has a long history of defence deal corruption. The opposition Bharatiya Janata Party (BJP) was quick to attack the Congress party-led government for not acting sooner on allegations that bribes had been paid in the deal.
Antony ordered the CBI investigation on Tuesday into the purchase of the luxury helicopters, which were destined for use by India's leaders.
"If any individual or foreigner, any firm, are involved in this malpractice, nobody will be spared. We will take action against them, whatever may be the consequences," he told reporters.
Finmeccanica's Alenia Aermacchi and AgustaWestland units are pursuing Indian business worth $12 billion this year, defence analysts IHS Jane's said, including more helicopters and military transport planes.
Prime Minister Manmohan Singh's government has been buffeted by scandals over the sale of mobile phone spectrum, coal fields and contracts for the 2010 Commonwealth Games in Delhi, and its record on graft will be a key issue in elections due by 2014.
In the 1980s, a multi-million dollar scandal over the purchase of Swedish Bofors artillery guns contributed to an election defeat for Congress and its prime minister, Rajiv Gandhi.
The Defence Ministry has put in place strict guidelines for arms deals in an effort to crack down on corruption. Last year, six companies including Rheinmetall Air Defence, part of Germany's Rheinmetall AG (RHMG.DE), were placed on a blacklist of arms firms banned from doing business in India. Rheinmetall strongly denied the allegations against it.
"I see the making of another Bofors in this," said opposition BJP spokesman Ravi Shankar Prasad.
The Bofors scandal implicated an Italian middleman close to the Gandhis, and the BJP often seeks to play up the Italian origins of Congress leader Sonia Gandhi, Rajiv's widow.
ALLEGATIONS IN OCTOBER
The Indian Express newspaper had access to Italian prosecution documents last October and ran a series of stories giving detailed accounts of the alleged bribery and named several Indians said to have been involved.
Prasad asked why the government had not launched a police investigation earlier.
"The suspicious circumstances surrounding this raises one fundamental question again - the fact that it was an Italian company, was it the grounds to go slow?"
Defence Minister Antony criticised Italy for not responding to requests for information about the case. "From day one, we have been trying to find out the truth and we conveyed that to them," he said. "So far we have not received any details."
He said his ministry's internal enquiries had so far found no evidence against Finmeccanica, but refused to answer specific questions about the Italian allegations, saying the CBI investigation would find the truth.
The Italian arrest warrant for Orsi said three cousins of former Indian air force chief Shashi Tyagi had received kickbacks and helped to twist rules in favour of AgustaWestland in the helicopter tender. None of the Tyagis has been accused of wrongdoing by officials in India.
Shashi Tyagi denied all wrongdoing and described the charges as "bunkum". Speaking at his home near Delhi, he said that a specified service ceiling of 18,000 feet (5,500 metres) had been reduced to 15,000 feet, but during a government led by the opposition BJP and before his time as air chief.
He said the change had been necessary because only one helicopter was able to fly that high.
Tyagi, who spoke openly and extensively with media on Wednesday about the case, also said the helicopter deal had been sealed three years after he retired from the air force in 2007.
Antony, who became defence minister in 2006, said he could not comment on accusations against Tyagi.
"I have no information within my hands ... How can I say anything? At the moment, I will not say anything against any individual unless I get some reports from CBI," he said.