Deccan, Indian's first discount carrier, is entering a tie-up with the more upmarket Kingfisher Airlines.
Kingfisher is owned by alcohol baron Vijay Mallya and is named after his flagship beer brand.
There is intense competition in India's aviation sector as more people become able to afford plane travel.
There are currently 10 Indian carriers, up from three in 2003, with at least 14 more airlines seeking government approval to start flying in India.
The merger follows earlier consolidation in the sector. The country's largest domestic carrier, Jet Airways, bought Air Sahara for $340m in April.