Prime Minister Manmohan Singh's cabinet has given the green light to the proposals, which will be debated by parliament next month.
Nearly one in three of India's 1.15 billion people is under 14, and Singh has said that improving educational standards is crucial if recent rapid economic development is to continue.
Many foreign universities already have links with Indian business schools or engineering colleges but the prospect of independent foreign campuses in one of the world's major emerging economies has attracted global interest.
Krista Knopper, who advises the Maastricht University in the Netherlands on India, said that the proposed legislation promised a revolution for Indian students.
"Maastricht will definitely follow developments around the foreign education bill in India and could be interested in starting a campus," she said.
"This is a very exciting time for India in developing its higher education structure."
Education is a priority in many Indian households, with children put under constant pressure to attain good marks in exams and earn a prized place at over-stretched universities, with a view to lucrative careers.
Government minister Kapil Sibal said on Wednesday that 800 to 1,000 new universities would be needed within ten years if the number of students going on to higher education was to rise from the present 12 per cent to 30 per cent.
"If we in this part of the world recognise the facts, we will realise how important education is for a developing economy," he said.
Vinod Mirchandani, Melbourne University's chief representative in India, said that all options were on the table.
"India is a very important market for us and Melbourne University is not closed to the idea of an offshore campus," he said.
For decades, the country's brightest and most privileged students have headed abroad to complete their studies, often never to return.
Many Indian leaders have studied at Cambridge or Oxford in Britain, including the country's first prime minister Jawaharlal Nehru, Indira Gandhi, Rajiv Gandhi, and the current premier, Singh.
About 100,000 Indians study at universities in the United States and 60,000 in other countries, according to the New York-based Institute of International Education.
The institute's Indian representative, Ajit Motwani, said that if passed, the bill would be "good for India's economic and social well-being" as it would lead to standards being raised in all colleges.
Britain's Lancaster University, which has an existing programme with the privately-run GD Goenka World Institute in New Delhi, endorsed Motwani's prediction.
"The bill is likely to benefit Indian students and will lead to more choice," said Paul Welling, Lancaster University's vice chancellor, in comments published this week.
However the issue of fees is likely to be highly contentious, as the planned legislation prohibits foreign universities from repatriating profits.
Among the many institutes that have sounded a note of caution, the United States' Stanford University said it would rather deepen collaboration than set up its own fully fledged facilities in India.
Lisa Lapin, Stanford's assistant vice president, told the Hindustan Times that "learning centres" and "research partnerships" had proved valuable in India for the university's current students and would probably be expanded.
The bill, which stipulates foreign institutes would have to deposit a start-up fund of $11 million, is likely to face a difficult time in parliament.
The BJP, the main opposition, is unhappy with the bill in its current form and communist lawmakers have vowed to block it.
"This bill excludes the weaker sections of society and reaps benefit only for the rich," said D. Raja, the general secretary of the Communist Party of India.
(Source: Telegraph.co.uk )