India on Friday allowed foreign airlines to purchase stakes of up to 49 percent in domestic carriers, a long-pending policy reform that could help cash-strapped local airlines.
"Denial of access to foreign capital could result in the collapse of many of our domestic airlines, creating a systemic risk for financial institutions and a vital gap in the country's infrastructure," a government statement said.
The country's airline sector was once vaunted as a symbol of economic vibrancy, but its fortunes have nose-dived because of over-expansion, high jet fuel prices and rising airport fees.
Except privately owned IndiGo, all Indian airlines posted losses in the financial year ending on March 31.
Friday's decision could throw a lifeline to companies such as debt-laden Kingfisher, which was the country's number two local carrier a year ago but is now in desperate need of funds to stave off bankruptcy.
"This is a huge positive as several domestic airlines need equity capital for expansion," said Sharan Lillaney, an aviation analyst at Mumbai's Angel broking.
"There may not be a flurry of investment, but whenever a country opens up for foreign investment, interest will be found."
Kingfisher boss Vijay Mallya, who has not paid staff full salaries since April, has repeatedly said he has had interest from foreign airlines, but has declined to name them.
According to the International Air Transport Association, India's major carriers lost close to $2 billion in the last fiscal year to March 2012 and are carrying debts of $20 billion.
The FDI announcement follows a bold 12 percent hike in the price of heavily subsidised diesel on Thursday night, which analysts saw as the government signalling its intent to reinvigorate its stalled and contested reform agenda.
The country of 1.2 billion is an area of huge opportunity for carriers as the average Indian takes only one airplane trip every 10 years, compared to the average American who takes two trips each year, analysts say.