It comes with 2.2 Froyo. You can install CM7 (2.3) if you choose to go that way.
Other phones in that meet your criteria are the Galaxy Ace and the Spice Mi 410.
Galaxy Ace has a 3.5-inch display with only HVGA resolution which gives it a poor ppi. Also it has an ARMv6 processor which does not support the full version of Adobe Flash.
The Spice Mi 410 has better features than the Defy, but there have been QC related-cases with the phone and not everybody is comfortable with spending 13-14k on a phone with reliability issues.