State-owned IMI is the main supplier of defense platforms for the Israeli military and is a significant exporter in the defense field.
The sector has become increasingly crucial to maintaining production lines and developing new systems at a time when the government is slashing Israel's defense budget.
The decision by the Indian government "is expected to significantly impact IMI's activities in India, as well as that of other Israeli defense firms," the liberal Haaretz daily reported following the announcement of the blacklisting Tuesday.
India banned middlemen in military deals following allegations of bribery in a multimillion-dollar artillery deal with Sweden's Bofors company in the 1980s. That scandal led to the downfall of the government headed by Prime Minister Rajiv Gandhi, leader of the Congress Party, in 1989.
Under Indian law, arms deals can be canceled if it's proved that kickbacks were involved. All deals are expected to be conducted directly between companies and the New Delhi government, without middlemen, although the law does allow payments for marketing and other expenses.
IMI was one of six foreign firms barred from bidding for Indian defense contracts for 10 years on suspicion of involvement in the corruption scandal that centered on Sudipta Ghosh, former director general of the state-run Ordnance Factory Board.
The other companies were listed as Singapore Technologies Kinetics, Rheinmetall Air Defense AG of Switzerland, Corporation Defense, Russia, and two Indian concerns, T.S. Kisan and Co. and RK Machine Tools.
IMI worked with India's OFB in a $24 million deal to set up five factories to produce 155mm Bi-Modular Charge Systems and other propellant charges for large-caliber artillery operated by the Indian army.
Indian authorities froze that project and have kept it on hold since.
On Tuesday, India's Defense Ministry said IMI and the other five defense companies "were recommended for blacklisting by the Criminal Investigation Bureau.
"They were issued with show-cause notices to explain why action should not be taken against them" following Ghosh's indictment in June 2010.
The blacklisting went ahead because the ministry found the companies' replies were "unsatisfactory."
The Indian indictment against Ghosh stated he was involved in a wide-ranging conspiracy that included receiving bribes from defense contractors in exchange for favoring them in Indian defense contracts.
India is a major arms buyer and on Jan. 31 announced it will purchase 126 Dassault Rafale multi-role fighters from France over the next decade under a $10.4 billion contract, one of the largest deals for combat aircraft.
In 2007, Israel dislodged France as India's second largest arms supplier after Russia.
The Ghosh scandal at one point also involved Israel Aerospace Industries, flagship of Israel's defense industry, and Rafael Advanced Defense Systems.
IAI pioneered selling to the Indian arms market even before diplomatic relations were established in 1993.
In mid-2007, New Delhi suspended dealings with IMI and six other arms manufacturers for alleged "illicit trading and bribery," effectively halting all dealings with them.
Tuesday's formal ban includes most of those listed in the 2007 suspension.
In December 2008, Israeli police launched at least four investigations into alleged bribery allegations against defense establishment officials, the first such probes after the introduction five months earlier of a law that outlawed bribing foreign public servants.
The Jerusalem Post reported at the time that one investigation involved alleged bribes of 6 to 9 percent paid out by two state-owned Israeli companies to Indian officials in a $1.5 billion missile contract.
The Post said the allegations "appear to be similar to those that surfaced in the Indian media on apparent bribes paid in the sale of Barak missiles to India, a case in which Israel Aerospace Industries and Tafal have been accused."
The Israeli companies denied any wrongdoing. None of the investigations resulted in criminal charges, apparently because the alleged bribery occurred before the law took effect.
However, the Organization for Economic Cooperation and Development criticized Israeli police for delaying the investigation into the India-related cases for several months.