The government plans to repeal a section of the Racial Discrimination Act that makes it illegal to "offend, insult or humiliate another" because of their race, saying it should not be used to stifle free speech.
It proposes inserting a new clause into the law to ban racial vilification - defined as inciting hatred against racial groups - rather than simply offending them.
"It will give licence to racism," Kirstie Parker, from the indigenous group National Congress of Australia's First Peoples, told Sky News. "We believe people will think it's open slather."
The Arab Council of Australia's Randa Kattan also views the proposal with deep concern, saying it threatens social inclusion and the government's relations with the Arab-Australian community.
"We've all seen what happened during the Cronulla riots - it doesn't take much to stir racism but it takes a long time to put it out," she said, referring to the ugly race riots between white and Lebanese Australians at Sydney's Cronulla Beach in 2005.
"So when the government says it's okay that people have the right to be bigots ... and then we follow up with these pretty severe changes to the Racial Discrimination Act, it's quite concerning."
Tri Vo, President of the Vietnamese Community in Australia, said the changes would put the country back 20 years.
"Instead of going ahead and with international communities and all that, living harmoniously with each other, we're going backwards," he told the ABC.
Attorney-General George Brandis has said he wants Australia to remain a fair, free and tolerant society where racism has no place, but has also defended the right of Australians to "be bigots".
"People do have a right to be bigots, you know," he told parliament in March. "In a free country, people do have rights to say things that other people find insulting or offensive or bigoted."
Brandis is expected to develop a draft bill for the cabinet in coming weeks.
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