A diplomatic standoff is brewing between India and Maldives, as in a sudden and unilateral action, Maldives on Tuesday decided to scrap the $500 million contract given to Indian firm GMR Group for developing Male Airport.

The Maldivian government had scrapped the deal with Indian firm GMR, deeming it null and void.

Reacting to it sharply, India has called the act a bad message for foreign investors. GMR has termed the cancellation as unlawful and has planned to take legal action.

A recent  report in Outlookmagazine over the weekend quotes pro-India politicians in Maladives as as saying that the step has been taken at the insistence of a pro-China lobby in the government.

According to the unnamed inside sources quoted in the report, a few elements in the Maldivian government want to push out the Indian company and rope in a Chinese firm instead.

Chinese companies are also eyeing the Gan International Airport in Addu Atoll in the Maldives and another one closer to the borders on Lakshadweep.

The mutual distrust between India and China has been growing in the Maldives. Much to the chagrin of the Indian government, the Maldivian government had allotted a key plot of land near the Indian High Commission in Male to China, the Outlook report says.

The Chinese government is planning to build its embassy there.

Another view is that the GMR issue has been raked up with an eye to gain political mileage by the Mohammed Waheed Hassan government. The elections are due in 2013.

Hassan had removed former President Mohamed Nasheed in coup-like operation in February this year.

Whatever the reason is, it is an embarrassing situation for GMR, which has been in the eye of a storm in India after the Comptroller and Auditor General’s scathing report that questioned the “undue favours” shown to the company.

It has already invested $250 million in the $500 million Maldives project.

The only hope for the company seems to be a speedier arbitration in Singapore, which it has already sought.