This followed the alleged threat of violence from Muslim groups protesting his book The Satanic Verses - banned in India in 1988 for passages allegedly blasphemous towards Islam.
Rushdie earlier cancelled his visit following an alleged Rajasthan government advisory - whose credibility he has questioned - that he could be targeted by the Mumbai mafia.
Islamic seminary Darul Uloom Deoband, which had demanded banning Rushdie's entry into India, welcomed the cancellation of the video-link. Its rector, Maulana Abul Qasim Nomani, said, "The government should always be careful about the religious sentiments of the community."
Rushdie had attended the festival in 2007 without incident. The controversy this year is being linked to coming assembly polls in five states, especially in Uttar Pradesh where 18% of the population is Muslim.
Rushdie termed the scrapping of his address "awful" on Twitter. "Threat of violence by Muslim groups stifled free speech today. In a true democracy all get to speak, not just the ones making threats."
He told NDTV a vast majority of Indian Muslims would not "give a damn" if he came or went. "I'm at a loss to understand why it has happened now. Everyone is saying it's connected to the UP elections."
The Indian-origin writer said The Satanic Verses was recently published in Turkey and Egypt and "un-banned" in Libya. "Yet in India, after 23 years, the ban still survives. Does India want to be a totalitarian state like China or move towards liberty of ideas?"
The BJP said the episode "exposed the Congress for its worst communal vote-bank politics" while the Congress said the row had no link to the UP polls.