India has blocked South Korean steelmaker POSCO from constructing a planned $12 billion plant in eastern Orissa state until villagers' land claims are settled.

Environment Minister Jairam Ramesh rejected late Thursday the state government's argument that villagers had no rights over the proposed plant site and said their claims must be subjected to "due process of law".

The proposed plant is India's biggest foreign investment deal since the launch of economic market reforms in 1991. It has been stuck in a bureaucratic and regulatory maze since 2005.

A final decision regarding vital forest clearance approval for the project will be taken once the locals' claims are examined, Ramesh said.

The plant would require some 1,235 hectares (3,050 acres) of forest.

The environment ministry has in recent months delayed or denied permission to several industrial projects, especially in mineral-laden, forest-rich eastern India.

The government has expressed concern about the impact of big plants and mining operations on local inhabitants and the environment.

The latest POSCO delay comes after India saw a sharp drop in foreign direct investment, which critics have partly blamed on regulatory and environmental uncertainty.

The 12-million-tonne capacity complex in Orissa is key to POSCO's global expansion strategy.