Governor Mike Pence signed Senate Bill 101 on Thursday at a closed-door ceremony attended by Catholic nuns, orthodox Jews and social-conservative lobbyists.
"It is vitally important to protect religious freedom in Indiana," the Republican governor said in a statement.
"It was therefore important to pass Senate Bill 101 in 2015 in order to help protect churches, Christian businesses and individuals from those who want to punish them because of their Biblical beliefs!"
But activists say it effectively makes it legal for Indiana businesses whose owners reject homosexuality on religious grounds to turn away LGBT customers.
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"They've basically said, as long as your religion tells you to, it's OK to discriminate against people," said Sarah Warbelow, legal director of the Human Rights Campaign, the nation's biggest gay rights group.
The Indiana chapter of the American Civil Liberties Union (ACLU) called the law a "backlash" response to a failed bid last year to put a gay marriage ban in the state's constitution.
Cloud computer giant Salesforce -- one of many big corporations that spoken out against the legislation -- said it will reconsider its investments in Indiana.
Gen Con, the world's biggest gaming convention with 56,000 attendees last year, said it might stop holding the event in Indianapolis, the state's main city, where it said it contributes more than USD 50 million to the economy.
Hollywood stars joined the furor via social media, where Ashton Kutcher likened the law to anti-Semitism and Miley Cyrus hurled an expletive at Pence.
Gay rights have made big strides in recent years, with marriage equality recognized in 37 states after the US Supreme Court in 2013 ruled that federal law could not discriminate against wedded LGBT couples.