The cabinet meeting, which took the decision here on Thursday, also decided that the settlement agreement would be submitted before the court after consulting legal experts and further action would be taken as per the court's directions, a government press release said.
The government had entrusted Former Chief Secretary K Jayakumar to examine the issues raised by Nambi Narayanan and settle the case amicably.
On the basis of Jaykumar's recommendations, the cabinet took the decision, the release added.
The government had last year handed over Rs 50 lakh to the former scientist, three weeks after the the apex court ordered the relief holding that he was "arrested unnecessarily, harassed and subjected to mental cruelty."
The espionage case, which hit the headlines in 1994, pertained to allegations of transfer of certain confidential documents on India's space programme to foreign countries by two scientists and four others, including two Maldivian women.
Narayanan had to spend close to two months in jail before the CBI concluded the allegations against him were false.
The case was first probe by the state police and later handed over to the CBI, which found the charges to be false.
The scientist had moved the Supreme Court against the Kerala High Court order, which said no action was required to be taken against former DGP Siby Mathews and two retired Superintendents of Police K K Joshua and S Vijayan, who were later held responsible by the CBI for his illegal arrest.
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