The India-US tax treaty states 'the tax treaty benefits will be lost retroactively if your stay in US exceeds 2 year period'. What does the phrase mean? Does it mean that if one has to be here for a 3rd year, he/she will have to repay ALL the tax in retrospect, including that of the first 2 years.

In other words, if your project demands you extend your stay beyond 2 yrs, do you have to repay all the tax amount that was exempted for you for the 1st 2 years?

Yes, you would have to pay the two years of taxes retroactively.