NEW DELHI/WASHINGTON – The U.S. energy secretary on Wednesday postponed a visit to India, while New Delhi ordered the U.S. Embassy to close a club for expatriate Americans, as a worsening diplomatic row exposed fault lines between the world's two most populous democracies.

Furious at the arrest, handcuffing and strip search of its deputy consul in New York last month, India has reacted by curtailing privileges offered to U.S. diplomats. The officer, Devyani Khobragade, was accused by prosecutors of underpaying her nanny and lying on a visa application,

Nearly a month on, the dispute has started to affect the wider relationship between the countries, with two high-level visits by U.S. officials postponed.

U.S. Assistant Secretary of State for South Asia Nisha Desai Biswal has delayed her first visit to India, which was due on Jan. 6, to avoid it becoming embroiled in the dispute.

On Wednesday, an official of the U.S. Energy Department said Energy Secretary Ernest Moniz would no longer travel to India as planned next week, the most serious repercussion yet in the row over Khobragade's arrest.

Both sides have said the relationship is important and will not be allowed to deteriorate - Washington needs New Delhi on its side as U.S. troops pull out of Afghanistan and as a counterbalance to a rising China. Millions of Indians have made the United States their home and bilateral trade is worth about $100 billion a year.

But the dispute over Khobragade has plunged the two countries into a crisis described by Indian media as the worst since New Delhi tested a nuclear device in 1998.

The aim of Moniz's trip was to promote trade and investment in the energy sector. The talks usually include discussions of civil nuclear trade between India and the United States.

The Energy Department official called the energy partnership a key element of the overall strategic partnership between Washington and New Delhi.

"In view of the importance of these matters to the overall bilateral relationship, we look forward to holding the Energy Dialogue at a mutually convenient date in the near future that will permit both sides to deliver concrete outcomes for both governments and our two peoples," he said.

India and the United States signed an agreement on nuclear energy cooperation in 2009, during the administration of former U.S. President George W. Bush, a high point in a relationship that is widely considered to have drifted since.

"I'm a little worried it may spin out of control," said Lalit Mansingh, a former Indian ambassador to the United States who has also served as India's top diplomat and is now retired.

India stepped up the pressure on Wednesday ahead of a Monday court appearance where Khobragade could be indicted, ordering the U.S. Embassy in Delhi to stop receiving non-diplomats at an embassy club popular with expatriate Americans for its swimming pool, restaurant and bar.

Americans working in the Indian capital have been frequenting the club for decades. An Indian government source said the club should not be offering services to non-diplomats when it has tax-free status.

In Washington, State Department spokeswoman Jen Psaki stressed the importance of relations with India and said the United States "endeavours to always be in compliance with local laws and regulations."

"We are continuing our conversations with the Indian government ... with the importance of the broad strategic U.S.-India partnership firmly in mind," she said.

Asked at a briefing if the United States was concerned by the Indian action, she said, "As we have concerns we will express them privately."

India had already curtailed privileges offered to U.S. diplomats to bring them in line with the treatment of Indian envoys to the United States. Since December, the U.S. ambassador in Delhi can be subjected to airport frisking and most consular staff have reduced levels of immunity.

Concrete barriers were removed from a road near the U.S. Embassy last month, apparently in retaliation for the loss of a parking spot for the Indian ambassador in Washington.

India is also preparing to take steps against the embassy school, which it suspects may be employing some staff in violation of visa requirements, a government source said.

Despite an overall improvement in ties since the end of the Cold War, the Khobragade dispute has brought a lingering wariness between the two countries into the open. Over the past year, there has been increasing friction over trade, intellectual property rights and visas for Indian IT workers.

There is also a legacy of mistrust, with some Indian officials whose professional life began when India was a close partner of the Soviet Union still not convinced Washington is a reliable ally.

Despite close security and economic cooperation now, many officials recall U.S. support of India's old enemy Pakistan and some believe Washington sees a strong India as a threat.

"For 50 years we were led to believe that the United States was an adversary. For the last 10 years we have been experimenting with a strategic partnership. It is not a done deal," said Mansingh.

Among some U.S. diplomats, there is a perception that while India insists on respect and friendship, it fails to deliver either in support on issues such as Iran or Afghanistan, or by giving enough commercial access to U.S. businesses.

Ways out

To defuse the spat, India wants the United States to approve Khobragade's transfer to its U.N. mission in New York, a move it believes would give her immunity from prosecution.

If that does not happen before the U.S. government begins a preliminary hearing or files an indictment, India could take more retaliatory steps, an Indian government source told Reuters.

U.S. officials hope for a resolution of the row through some sort of plea-bargaining process.

In a column published this week, Indian Human Resource Minister Shashi Tharoor asked whether an era of steadily improving ties had come to an end.

"Indian-American relations had been strengthening owing to both sides' shared commitment to democracy, common concerns about China, and increasing trade and investment," he wrote.

"The Khobragade affair suggests, however, that all this is not enough: sustaining a strategic partnership requires, above all, mutual respect."

Legacy

The United States had high hopes that not only would India emerge as a counterbalance to a rising China but as a new growth engine for the U.S. economy.

Frustration has grown, however, among the U.S. corporate lobby. Indian sourcing rules for retail, IT, medicine and clean energy technology are contentious and U.S. firms gripe about "unfair" imports from India of everything from shrimp to steel pipes. In June, more than 170 U.S. lawmakers signed a letter to President Barack Obama about Indian policies they said threatened U.S. jobs.

With general elections due in India in four months, and congressional elections in the United States in November, the fear is that the current dispute will make it harder for both sides to stick their necks out and make progress on thorny issues such as liability for nuclear equipment suppliers.

"There is such a long laundry list of concerns on the American side that seem to be ignored or slow-rolled inIndia,' said Persis Khambatta at the Center for Strategic and International Studies think tank. "The risk is that this (Khobragade) incident will dig up a lot of frustration that had built up."