NEW DELHI, July 20 (Reuters) - It was meant to be the cornerstone of relations between the world's two biggest democracies, but a lucrative nuclear deal that was to welcome U.S. firms into India's $150 billion atomic power market is clouding otherwise warming bilateral ties.
While the 2008 U.S.-India civil nuclear agreement backed by then President George W. Bush elevated relations and ended India's nuclear isolation, it has yet to benefit private U.S. firms which have kept away, deterred by a stringent Indian law on accident liability that could force such firms to pay out billions in the event of a nuclear accident.
"Two reactor sites have now been set aside for American companies in future," said a senior U.S. official travelling with Hillary Clinton during her visit to India.
"It would be a very serious problem if India were to come out with regulations that were not in fact in compliance with (a global convention governing nuclear liability) and then left us out in the cold not being able to profit from all of the hard work that we've put into that," the official added.
Clinton on Tuesday pressed India to accede to the multilateral convention to assure its suppliers any liabilities would be in line with international norms.
The impasse has meant rival state-backed nuclear reactor makers from Russia and France have raced ahead in tapping into India's nuclear power market, leaving Washington to lobby New Delhi to water down the law that was passed last year.
While overall ties are on an upswing, the standoff over nuclear trade is being seen by many as nettlesome, potentially slowing cooperation between two of the world's biggest markets.
"As it stands it's a big problem because the United States had put in so much political capital into the deal and its commercial interests are being hurt," said Robinder Sachdev, the head of strategic think tank ImagIndia Institute.
"Any bad blood from this could spill over into other aspects of the wider ties which were otherwise doing well."
India's parliament passed laws in August to open up the domestic nuclear market. But its nuclear liability law also gives the right to seek damages from plant suppliers if there is an accident.
India is the only country to have such a provision, which was added after wide political pressure, partly stoked by painful memories of industrial calamities such as India's Bhopal disaster in 1984 when plumes of poisonous pesticide from a U.S.-run Union Carbide plant killed thousands.
That move has made the entry of firms like General Electric and Westinghouse Electric, a U.S.-based unit of Toshiba , into India uncertain unless the country provides more clarity on compensation liability for private operators.
On Tuesday, U.S. Secretary of State Hillary Clinton told Indian officials to amend the law but analysts say it will be almost politically impossible for New Delhi to water it down.
"The penny will finally drop on the Americans as they realise the Indian liability law cannot be diluted and they will have to look for other get-arounds like factoring in liability in the pricing structure (for reactors)," said Siddharth Varadarajan, strategic affairs editor of The Hindu newspaper.
The United States has also pressed India to accede to the multilateral Convention on Supplementary Compensation for Nuclear Damage (CSC) to assure its suppliers any liabilities would be in line with international norms.
India is seen by the United States as a key geopolitical player for stability in South Asia, as well as a counterweight to a rising China. Its vast economy, along with China's, is seen as a locomotive that can help revive moribund western economies.
India, which conducted nuclear tests in 1974 and 1998, has so far proven to be a responsible and benign nuclear state, though a bitter rivalry with fellow nuclear-armed Pakistan has made nuclear proliferation a latent risk in the subcontinent.
The 2008 civilian nuclear pact scrapped a 30-year U.S. ban on supplying India with nuclear fuel and technology but it was criticised for undermining the global nuclear non-proliferation treaty which states that only nations which renounce nuclear arms qualify for civilian nuclear assistance.
Beyond the nuclear sphere, India has pledged to buy billions in U.S. military hardware while bilateral trade is up from $5.6 billion in 1990 to $36.5 billion in 2009/10.
"Indian investments in the U.S. are higher than American investments in India which shows the relationship is well-rounded," said Lalit Mansingh, a former Indian ambassador to Washington.
Though the risk of this cooperation unravelling is low, the logjam over the Indian liability law could slow progress.
"There is concern and disappointment both at the government and industry level," said Sachdev. "It's more than an irritant." (Additional reporting by Andrew Quinn in Chennai; Editing by James Pomfret and Sugita Katyal)