Prime Minister Narendra Modi is preparing to launch India's biggest overhaul of labour laws since independence in a bid to create millions of manufacturing jobs, at the risk of stirring up a political backlash that could block other critical reforms.

Three officials at the central labour ministry told Reuters that the ministry was drafting a bill for the upcoming parliamentary session that proposes to loosen strict hire-and-fire rules and make it tougher for workers to form unions.

The changes, if approved by Parliament, will be the biggest economic reform since India opened its economy in 1991, but it is likely to meet stiff opposition in Parliament and from labour activists.

The prime minister enjoys a majority in the Lok Sabha, but not the Rajya Sabha, hobbling his ability to pass politically contentious measures.

That handicap has stymied his efforts to make it easier for businesses to buy farmland and convert Asia's third-largest economy into a common market.

Rajiv Biswas, Asia-Pacific chief economist at IHS Global Insight, said Modi had little option but to push ahead with the measures.

"Without these reforms, the economy would stagnate, and frustrated investors would look elsewhere," he said.

"You cannot make political opposition an excuse for not taking tough decisions."

Since taking office in May last year, Modi has taken a series of incremental steps to make labour laws less onerous for businesses, but fear of a union-led political backlash made him leave the responsibility for unshackling the labour market with Indian states.

He let his party's governments in Rajasthan and Madhya Pradesh take the lead in this area.

Encouraged by a successful and peaceful implementation of the measures in those states, the federal labour ministry now intends to replicate them at the national level, one of the ministry officials said.

Manish Sabharwal, one of the brains behind Rajasthan's labour reforms and co-founder of recruitment firm Teamlease, said the federal administration would have been better off without attempting these changes.

"Let states carry out these changes and save your political energy for other policy reforms," he said.

EASIER FIRING

As part of the proposed revamp, a factory employing fewer than 300 workers would be allowed to lay off workers without government permission. Currently, factories employing 100 workers or more need approval for layoffs.

But they will have to pay three times the current severance package, the labour ministry officials said.

Companies have long been demanding an increase in the ceiling as governments rarely grant such permissions for layoffs, making it difficult to respond to business downturns and encouraging them to stay small.

"It will facilitate ease of doing business while ensuring safety, health and social security of every worker," a senior labour ministry official involved in the deliberations said.

The official said the bill was expected to be finalised in the next three or four weeks, and would then be sent to cabinet for approval.

The planned changes would also make it tougher for employees to form unions or go on strike, but would make all employees eligible for minimum wage.

The World Bank says India has one of the most rigid labour markets in the world. That in turn has been a drag on manufacturing, which accounts for only 16 percent of India's $2 trillion economy, compared with 32 percent of China's.

Some 84 percent of India's manufacturers employed fewer than 50 workers in 2009, compared with 25 percent in China, according to a study published by consultancy firm McKinsey & Co. last year.

Economists cite current labour rules as the biggest constraint on Modi's "Make in India" ambition to spur a manufacturing boom creating jobs for 200 million Indians reaching working age over the next two decades.

Just 8 per cent of manufacturing workers in India are in formal employment, the rest are short-term contractors who enjoy minimal social security benefits.

It will take deft political management to ensure a speedy passage for the bill.

Opposition parties have blocked Modi's land bill in parliament, calling it "anti-farmer". The labour reforms, which are being opposed by labour unions, could also end up being labelled as "pro-corporates".

An official in Modi's office didn't rule out holding off the bill due to short-term political considerations.

"They may introduce it, but the progress would be very slow," said Kilbinder Dosanjh, a director at the Eurasia Group consultancy.