As a child I have seen few mythological series like the Ramayana & Mahabharata and have heard this word 'Arya' many times but don't think it was in context to Aryan race!
Speaking of the Aryan invasion theory, it would probably be an oversimplification to say: "Germans invented it, British used it," but not by much. The concept of the Aryans as a race and the associated idea of the 'Aryan nation' were very much a part of the ideology of German nationalism.
Before getting to the role played by German nationalism, it is useful first to take a brief look at what the word Arya does mean.
The first point to note is that the idea of the Aryans as foreigners who invaded India and destroyed the existing Harappan Civilization is a modern European invention; it receives no support whatsoever from Indian records - literary or archaeological. The same is true of the notion of the Aryans as a race; it finds no support in Indian literature or tradition. The word 'Arya' in Sanskrit means noble and never a race. In fact, the authoritative Sanskrit lexicon (c. 450 AD), the famous Amarakosa gives the following definition:
mahakula kulinarya sabhya sajjana sadhavah
An Arya is one who hails from a noble family, of gentle behavior and demeanor, good-natured and of righteous conduct And the great epic Ramayana has a singularly eloquent expression describing Rama as:
arya sarva samascaiva sadaiva priyadarsanah
Arya, who worked for the equality of all and was dear to everyone.
The Rigveda also uses the word Arya something like thirty six times, but never to mean a race. The nearest to a definition that one can find in the Rigveda is probably:
praja arya jyotiragrah ... (Children of Arya are led by light)
RV, VII. 33.17
Julian Huxley, one of the leading biologists of the century, wrote as far back as 1939:
In 1848 the young German scholar Friedrich Max Muller (1823-1900)
settled in Oxford, where he remained for the rest of his life. ...
About 1853 he introduced into the English language the unlucky term
Aryan as applied to a large group of languages. ...
As far as ancient India is concerned, one may safely say that the word Arya denoted certain spiritual and humanistic values that defined her civilization. The entire Aryan civilization - the civilization of Vedic India - was driven and sustained by these values. The whole of ancient Indian literature: from the Vedas, the Brahmanas to the Puranas to the epics like the Mahabharata and the Ramayana can be seen as a record of the struggles of an ancient people to live up to the ideals defined by these values.
Let us now take a final look at this famous theory. It was first a theory of Europe created by Europeans to free themselves from the Jewish heritage of Christianity. This was to lead to Hitler and Nazism. This theory was later transferred to India and got mixed up with the study of Sanskrit and European languages. Europeans, now calling themselves Indo-Europeans became the invading Aryas and the natives became the Dravidians. The British hired Max Muller to use this theory to turn the Vedas into an inferior scripture, to help turn educated Hindus into Christian collaborators. Max Muller used his position as a Vedic scholar to boost German nationalism by giving scriptural sanction to the German idea of the Arya race. Following German unification under Bismarck, British public and politicians became scared and anti-German. At this Max Muller, worried about his position in England, got cold feet and wriggled out of his predicament by denouncing his own former racial theory and turned it into a linguistic theory. In all of this, one would like to know where was the science?
More can be read in details here
Found an interesting presentation ruling out rightly the so-called AIT. Watch here on youtube.