New Delhi is wary about awarding new technology business to Chinese firms both because of security fears and a desire to get Indian manufacturers to produce more telecoms equipment.
"We cannot prioritise economic gains if an investment poses national security risk," one of the officials said.
Beijing hit back at the latest sanctions, accusing the US of "abusing state power" to crack down on Chinese companies "for no reason".
Xiaomi said in a statement that "it is not owned, controlled or affiliated with the Chinese military, and is not a 'Communist Chinese Military Company'".