MUMBAI - Indian vehicle maker Mahindra & Mahindra has bought two small Australian firms to build its aerospace capacity so it can compete for large orders from airline manufacturers modernising Indian defence forces.

The company on Tuesday said it and India's Kotak Private Equity had bought majority stakes in component firm Aerostaff Australia and aircraft maker Gippsland Aeronautics for 1.75 billion rupees ($37.5 million).

Hemant Luthra, a Mahindra group management board member, said the Australian firms would get a small upfront payment, some shares in the group's aerospace unit, and be eligible for milestone payments.

Most of the investment would go towards a new plant in south India, he said.

Aerostaff supplies components to companies such as Boeing, Airbus EADS.PA, said Luthra, but the firms were not in a position to scale up their operations.

They have now got somebody like Mahindra coming in with the capital. They have the ability to scale up, able to duplicate the facilities in India, he said.

India's defence policy mandates that foreign contractors source components and systems from local vendors for at least 30 percent of the value of the orders they get.

The offset opportunity is $750 million a year for the next 10 years with Indian defence forces likely to modernise their airline fleet at a cost of nearly $25 billion, Luthra said.

Companies such as Mahindra are eyeing a potential $100 billion Indian defence market over the next 10 years.

Last month, the chief executive of Mahindra's defence unit told Reuters it was looking to bid for $3.5 billion defence deals and expected to ramp up revenues to $430 million by 2016. ($1=46.7 rupees) (Reporting by Narayanan Somasundaram; Writing by Janaki Krishnan; Editing by John Mair)