Public “panic” over immigration is causing economic harm to the UK, Vince Cable has warned.
He said overseas students were being deterred from studying at British institutions and tight visa controls were causing difficulties for foreign experts working in the country.
The Business Secretary said foreign students were being caught up in the "very torrid and emotional" argument about the number of immigrants in the UK.
Mr Cable insisted there was no cap on the number of overseas students but there was a problem of perception.
Speaking at the Global Universities Summit in Westminster, he said the debate over immigration "does incubate these very deep emotional feelings about foreigners".
Highlighting problems with the visa regime, he said: "I was at one of our leading engineering companies a few months ago.
"I was introduced to the chief engineer, who was making the most sophisticated engines for Formula 1 cars and he happened to be Indian, and he was coming to the end of his visa and under the existing rules he was going to have to go back to India and reapply for admission to the UK, right in the middle of a high-pressure contract. It was completely absurd.
"But that is the kind of restriction that is introduced in order to placate public panic that does create an economic harm."
Prime Minister David Cameron has said he wants to see net migration fall to the "tens of thousands" by 2015.
Official figures last week showed that in the year to September 2012 net migration fell, with a 22% decrease in the number of foreign students.
Because overseas students were counted as immigrants under international rules, Mr Cable said their number was "easily translated into a flood of immigrants".
He added: "When, last week, the number declines, this is a great triumph for immigration control, which is quite absurd and unfortunately is seriously distorting the debate on sensible university policy and, indeed, sensible immigration policy.
"I just want to make absolutely clear, as far as the Government is concerned we have no cap on the number of overseas students, we don't propose to introduce one."
He acknowledged there was a "serious problem" of perception which had been caused by the Government's immigration restrictions, particularly in India.
"In India there has been a quite vigorous criticism of the UK, largely I think following the debate in British newspapers and treating that as if it was objective reality, which it isn't necessarily," Mr Cable said.
"In some of the Indian vernacular newspapers the message has gone out that the British no longer want Indian students, which is wrong but that's the message that has gone out."
There had been a "substantial" reduction in the number of Indian students as a result, he added.
Mr Cable's concerns about a reduction in foreign students were echoed by London Mayor Boris Johnson at the same event.
Mr Johnson said: "I looked at the recent figures for foreign students coming to this country and I do not regard what seemed to me to be a reduction in those numbers as necessarily a positive economic indicator.
"I think we need to push higher education as a great, great international export and we need to be even more open in our dealings with other HE institutions around the world."