India formally eliminated restrictions on foreign investment in its single-brand retail sector on Tuesday, opening the door to the likes of Swedish furniture giant IKEA to open stores in Asia's third-largest economy.

Foreign retailers that want to invest beyond the previous cap of 51 percent ownership will need to source 30 percent of their goods from small and village industries, said the government, which faces five state elections in the next few months.

Big local retailers cheered the change, which was pushed through by a government that has struggled to shake off perceptions of policy drift at a time when economic growth is slowing and inflation remains above 9 percent.

"This is a welcome move with a clear potential to lift the general mood in the economy," said Rajan Bharti Mittal, managing director of Bharti Enterprises, which operates a cash-and-carry business in partnership with Wal-Mart Stores Inc (WMT.N).

Apart from improving consumer choices, the change will help to make Indian enterprises more efficient by improving access to global designs, technologies and management practices, he said.

Tuesday's decision did not come as a surprise, although Prime Minister Manmohan Singh's attempts to free up the retail sector have met fierce political opposition and protests by small retailers who fear it will kill their livelihoods.

In December, the government suspended plans to open India's $450 billion supermarket sector to foreign firms, backtracking from one of its boldest reforms in years in the face of the backlash.

The retreat, within two weeks of the policy being announced, was seen as another nail in the coffin for Singh's economic reform programme.

Removing restrictions in the single-brand sector -- which was announced at the same time as the supermarket policy change -- was relatively uncontroversial.

SUPERMARKET POLICY ON PAUSE
Single-brand retailers such as Britain's Marks & Spencer (MKS.L) have built a major presence in India, riding an economic boom that has created a swelling, affluent middle class.

Others, such as IKEA, have said they would only enter the country when investment restrictions were eased.

Tuesday's announcement may not hasten a policy change in the supermarket sector, known locally as multi-brand.

Closely watched by the likes of Wal-Mart, France's Carrefour (CARR.PA) and Britain's Tesco Plc (TSCO.L), such a move remains politically dangerous for the coalition government.

"The notification was expected because single-brand is less controversial, as the brand will not compete with a local retailer," said Bijou Kurien, who heads the lifestyle division of Reliance Retail, which runs department stores, hyper-markets and supermarkets.

Reliance, a unit of industrial conglomerate Reliance Industries, has joint ventures with Marks & Spencer, U.S. home improvement giant Home Depot and U.S. clothing chain Diesel, among others.

"Our partners are quite happy and have no plans of a JV buyout," Kurien added.

Swedish fashion retailer Hennes and Mauritz (H&M), the world's second largest apparel retailer, said that while India was an interesting market, it was too early to comment on any plans it had to open stores.