India's planned deal to buy 126 fighter-jets from Dassault Aviation could be delayed, a defence ministry source said.
India picked the Dassault-made Rafale jet for exclusive negotiations in January 2012 after a hotly contested bidding war with rival manufacturers, but it is still to finalise the $15 billion deal, one of the world's largest defence import orders.
Under the initial terms of the proposed deal, Dassault was expected to provide 18 fighters in "fly-away" condition, and then let HAL manufacture the rest in India.
However, Dassault now wants two separate contracts to be signed - one for the ready-made ones, and another for the rest to be built by HAL, but India opposes that proposal, the defence ministry source, who is familiar with the developments, said.
"Dassault says HAL does not have the capacity and capability to assemble the aircraft," said the source, who declined to be identified because he is not authorised to speak to the media.
"HAL is our main public sector partner. And if needed, capacity and capabilities can be improved. But the proposal for two contracts is not agreeable to the government of India," he said.
The source said the dispute would likely delay finalising the deal but not derail it. Indian defence ministry officials had earlier expressed the hope that the deal could be finalised by July.
An India-based spokeswoman for Dassault did not immediately respond to an email seeking comment.
Dassault has agreed to supply manufacturing kits and equipment to HAL on time, but will not play a further role in manufacturing after that, the Indian Express newspaper said.
Negotiations between the company and the Indian government have completely stopped over the disagreement, the paper reported, without identifying its sources.
A Defence Ministry spokesman did not have any immediate comment.
Dassault has previously expressed doubts about the technological capability of HAL to manufacture such a sophisticated fighter jet.
A HAL programme to manufacture advanced jet trainers is running years behind schedule.
Rafale defeated the Eurofighter Typhoon to win the Indian government deal.
The Typhoon is developed by a consortium of BAE Systems, Finmeccanica and EADS.