South Africa is planning to require "Made in the Occupied Palestinian Territories" labels on products from settlements in place of "Made in Israel" labels, the trade ministry said on Saturday.
The move prompted a furious response from Israel's foreign ministry which described it as "racist".
EU member Denmark also said it would begin marking Israeli goods originating in Judea and Samaria with a special label, a Danish newspaper reported Sunday.
"For now, there is no decision but people should know that South Africa recognises Israel inside the 1948 UN borders," Macdonald Netshitenzhe, the trade ministry's director for trade policies and legislations, told AFP.
"Now coming to the issue of Palestine and Israel, a product from Israel has to be manufactured or produced within the borders of 1948," he said.
"Therefore, for the goods or vegetables which are grown in the area where Israel invaded other Arab countries, South Africa says, you better say these products are grown in Palestine or Occupied Palestinian Territories," Netshitenzhe added.
Trade and Industry Minister Rob Davies said on Wednesday the move was aimed at helping "South Africans who do not support Israel, but who in fact do support the Palestinians, to identify those products."
"This doesn't, however, mean any kind of boycott of Israeli products," he said, in remarks quoted by South African news agency SAPA.
Palestinians and their supporters, inspired by the economic boycott of apartheid-era South Africa, have been trying for years to spark a punishing economic war on Israel. Until now their campaign of divestment and boycott has had negligible economic effect, but the voice of the South African government could be a symbolic boost.
Israel's foreign ministry reacted angrily to the news, with spokesman Yigal Palmor telling AFP that South Africa's ambassador to Israel would be summoned for an explanation in the coming days.
"This is not a political objection to settlements, rather the act of singling out a state by a special marking system based on national-political criteria. Therefore, it is by essence a racist move," Palmor said.
"It is shocking to think that South Africa, of all countries, would display such callousness, and is blindly marching down the slippery slope of racism."
Israeli Deputy Foreign Minister Danny Ayalon said Israel would summon the South African ambassador to protest the proposal.
Meanwhile, in an interview with a Dansih newspaper, Danish Foreign Minister Villy Sovndal explained his government decision to begin marking Israeli goods originating in Judea and Samaria with a special label.
This is a step that clearly shows consumers that the products are produced under conditions that not only the Danish government, but also European governments, do not approve of. It will then be up to consumers whether they choose to buy the products or not."
Sovndal added that the measure was part of EU support for the Palestinians and the solution of two states for two peoples. He added that the measure was not a boycott of Israeli goods, but targeted goods originating in illegal settlements in the West Bank.
He said that the labeling would be optional for supermarkets, and that it was intended to allow consumers to better differentiate between products produced in Israel, which are subject to preferential customs agreements, and those made in settlements in the West Bank, which are not.