FEDERAL Trade Minister Simon Crean has warned that Australia could face trade retaliation over the NSW Government's new "buy local" policy.

Mr Crean said the policy was a "reversion to protectionism" which undermined Australia's free-trade credentials.

He said the US and the European Union - which Australia has criticised over dairy export subsidies and the US's "Buy American" plan - had already asked questions about the NSW move.

Last week, the NSW Budget outlined plans for a 20 per cent cost advantage to contractors bidding for government work who use NSW suppliers.

A further 5 per cent advantage will be given where inputs are sourced from regional NSW.

NSW Treasurer Eric Roozendaal said there'd been a "bit of misunderstanding" about the plan.

"We're not banning anybody's imports or anybody's goods. What we're saying is . . . we're seeking some more local content," Mr Roozendaal said.