The foreign groups will be able to buy stakes of up to 51 percent in multi-brand retailers, allowing them into a previously protected but potentially hugely lucrative sector, Information Minister Ambika Soni said.
Reports also said that rules governing foreign investment in the aviation sector had been relaxed and the cabinet had also approved the sale of stakes in four state-owned companies.
The moves follow a bold 12 percent hike in the price of heavily-subsidised diesel on Thursday night, which some analysts saw as the government signalling its intent to reinvigorate its long-stalled reform agenda.
Last December, the beleaguered left-leaning national government was forced to withdraw the proposal to allow in foreign supermarkets in the face of fierce resistance.
Shopkeepers, opposition parties and even an ally in the national coalition came together to oppose the change in the law, saying it would destroy the livelihoods of small business owners.
The government sees foreign supermarkets as a way to improve the food supply chain and bring down food prices.
The sale of stakes in the state-run companies and the increased diesel price are aimed at repairing the government's finances which are under strain from slowing economic growth and a growing burden of subsidies.
Prime Minister Manmohan Singh will now face the delicate task of keeping his coalition government together given the known opposition to foreign investment in retail from unreliable coalition partner the Trinamool Congress.
Firebrand Trinamool leader Mamata Banerjee, whose power base is in West Bengal state, said on Thursday that she was angry and wanted the diesel hike reversed.
The reform of the aviation sector will potentially throw a lifeline to companies such as debt-laden Kingfisher, which is in desperate need of funds to implement a turnaround plan.
Foreign airlines are currently barred from taking stakes in Indian airlines, though other overseas investors can hold up to 49 percent.
Under the reform, airlines would be able to buy stakes of up to 49 percent.