Under the new policy, the government will allow domestic companies to bid for key projects on their own.
Indian companies until the policy change were not invited by the government to bid for big government defence projects and were left to supplying locally made non-combative equipment for the defence forces.
With foreign countries reluctant to share advanced technology with India, the government wants to encourage private defence companies to enter the arms market, officials say.
"The field is now open for them to come and bid for any project along with the world’s best. The government is giving them an opportunity to expand their capabilities," Sitanshu Kar, the defence ministry spokesman said.
Local companies are free to bid for projects involving tanks, artillery and aircrafts, Kar said.
"This move can also save costs and help us turn India into a major production hub in the near future," Kar said.
The new policy will provide more opportunities to Indian companies such as Tata Motors, Mahindra and Mahindra MAHhM.BO, Ashok Leyland and Larsen and Toubro, defence experts and officials said.
"The current review is primarily focused on two essential areas of promoting and facilitating wide participation of defence industry and enabling transparency and integrity in all acquisitions," defence minister AK Antony said at a conference.
"Over the next five to six years, the total budgetary provision for capital acquisition is likely to reach $50 billion," Antony said. Defence and company officials say it will touch the $100 billion mark in 10 years.
India wants to upgrade its largely Soviet-era arsenal to counter potential threats from Pakistan and China. The government plans to spend more than $30 billion over the next five years to upgrade its defences.
Foreign defence companies have welcomed the government move.
"The government is very forward leaning and the steps we view as a sign of the government’s confidence in the maturity of the Indian industry," Vivek Lall, India country head for Boeing Integrated Defense Systems said last week.