Roy, winner of the prestigious Booker award for her novel The God of Small Things in 1997, is a fierce critic of India's tactics in Kashmir, where protests against New Delhi have claimed more than 100 lives since June.
She shared a stage with hardline Kashmiri separatist leader Syed Ali Shah Geelani last week and backed the idea of "azadi" or freedom for Kashmir, leading New Delhi police to look into charging her with sedition.
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But the police have been instructed to "avoid pursuing the issue and consider it as a closed chapter", said a senior official in the Indian interior ministry, who asked not to be named."No criminal case has been registered against her. Therefore, there is no question of slapping sedition charges," the official said.
The Hindu nationalist Bharatiya Janata Party objected to Roy's remarks, calling them "seditious" and demanding legal action against her.
Kashmir has been beset by anti-India violence, curfews and strikes since early June, when a 17-year-old student was killed by a police tear-gas shell. Since then, a total of 111 protesters and bystanders have died.
A poll published last month showed that a majority in Muslim-majority Indian Kashmir favoured independence for their region.