A high-level probe was also ordered into alleged corruption in the department, Food and Civil Supplies Minister Harun Yusuf said.
The minister said government has recommended to Lt Governor Najeeb Jung to take punitive action against an Assistant Commissioner of the Food and Supplies department after finding him involved in "wrongdoings".
The government action came after a TV channel aired a sting operation showing irregularities in the public distribution system.
"We have ordered an investigation into the allegations of irregularities in the public distribution system. We knew irregularities are taking place in disbursal of the food grains. We will firmly deal with the corrupt elements," Yusuf said.
"We have also cancelled license of six fair price shops," he said.