NEW DELHI (Reuters) - India increased annual defence spending by about 11.6 percent on Monday, aiming to overhaul the military to counter the rapidly growing capabilities of giant neighbour China. The hefty increase suggests the government plans to move ahead with some of a slew of planned defence acquisitions, analysts said, including a $10.5 billion fighter jet contract, one of the worlds largest on offer.India, among a host of countries wary of Chinas economic and military heft, is also eyeing surveillance helicopters, transport aircraft and submarines to beef up defences in the air as well as in the Indian Ocean. Finance Minister Pranab Mukherjee, presenting the 2011-2012 budget to parliament, set the military budget at just over 1.64 trillion rupees ($36.28 billion), up from last years 1.47 trillion rupees. Last year the increase was about 4 percent. China is the real long-term challenge on the strategic horizon and Indias security planning is geared toward it, said retired brigadier Gurmeet Kanwal who heads the government-funded Centre for Land Warfare Studies. China, which considers the US military as its main rival, set its defence spending at $78 billion last year. It is expected to announce a defence budget for 2011 later this week ahead of an annual session of parliament. The core US defense budget - not including war funding - was $530 billion in 2010. More than 40 percent of the Indian defence budget for 2011 will be spent on capital expenditure, Mukherjee said, while the rest will go towards maintaining one of the worlds largest standing armed forces. Needless to say, any further requirement for the countrys defence would be met, he said seeking to assuage concerns that the rise in spending was short of the militarys expectations. Indian officials expect to conclude negotiations to buy 126 combat aircraft by the end of the current fiscal year, the countrys largest-ever defence order. Saabs JAS-39 Gripen is competing with Boeings F/A-18 Super Hornet, Dassaults Rafale, Lockheeds F-16 and Russias MiG-35 to win the fighter contract which Indian officials said can eventually go up to 200 aircraft. Kanwal said the defence allocation was enough to proceed with the fighter aircraft deal, although it may not leave much room for other arms imports. In the first year there is a signing amount you have to pay which shouldnt be a problem, he said. India, which traditionally has had an edge over China in terms of combat air superiority with more modern planes, has in recent years seen the gap closing as Beijing modernised its air force. Chinas plans for a stealth aircraft, designed to rival the US F-22, have in particular unnerved Indian security planners prompting a race to overhaul the air force with its Soviet-era planes. India, which long focused its military planning on Pakistan, is also scrambling to modernise its navy to counter Chinas influence in the Indian Ocean through its string of pearls strategy of developing a network of friendly ports from Gwadar in Pakistan to Hambantota in southern Sri Lanka. Another military expert said given the scale of the challenge facing India, the increase in defence expenditure was modest.