China in February barred its airlines from participating in the scheme without government approval. Beijing has also reportedly suspended the purchase of €10.6 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, who had direct knowledge of talks between the EU and other countries on the issue, said 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.
“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 source 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 question is: 'Are you [the EU] provoking the world into a trade war?"
Amber Dubey, a director at the global consultancy KPMG, said that a significant share of the orders to upgrade India’s civilian and defence fleets came 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.
Airbus has a 73% share of the commercial plane market in India, with orders for more than 250 planes in India’s fast-growing India market.
India says that 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 law did not breach international agreements.
The EU scheme has been widely criticised by the aviation industry, and on 13 March, 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 said.
Earlier this month, India inadvertently delayed approval of some European summer schedules by a day, disrupting some European airlines flight schedules.
The official said India may use that delay as an example of how disruptive a trade dispute could be.
Brussels introduced a carbon charge for all flights on 1 January after more than a decade of talks at the UN’s International Civil Aviation Organization (ICAO) failed to agree on a way to curb the sector's rising emissions.
Efforts to come up with an alternative plan at the ICAO have accelerated lately, and a working group is slated to report back in June.
The European Commission says 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.