A lower import tax could boost the country's gold demand and support global prices that are currently trading near their highest in 17 months.
The bullion industry has been urging a tax reduction to combat smuggling, which has increased since India raised the import duty to 10 per cent in August 2013 to narrow its current account deficit.
"We are expecting a 2 to 4 per cent reduction in the import duty," Saurabh Gadgil, the vice president of the Indian Bullion Jewellers Association (IBJA), told Reuters.
"Higher duty has opened up grey channels. The reduction is necessary to bring down the smuggling and unauthorised sales."
In 2016, smugglers brought in 120 tonnes of gold to India, according to World Gold Council estimates.
The smugglers sell gold at a discount to official domestic price and disrupt the business operations of banks and bullion dealers, said Harshad Ajmera, the proprietor of JJ Gold House, a wholesaler in the eastern Indian city of Kolkata.
"Smugglers can offer a 1 or 2 per cent discount as they are saving 10 per cent import duty. We could not give discounts. We have to pay the duty," he said.
The discounted prices offered by the smugglers along with the lack of demand ahead of the potential tax cut has lowered the market offers to discounts of about $2 an ounce, said the three bank dealers.
Tax evaders prefer to buy smuggled gold since they do not have to pay the 3 per cent Goods and Services Tax (GST), said Daman Prakash Rathod, a director at MNC Bullion, a wholesaler in Chennai.
"So the government first loses 10 per cent import duty and then GST as well," he said.
In India, less than 4 per cent of the people pay income tax. Many tax evaders choose to park their illicit wealth in gold as it is nearly as liquid as currency in the country.
The Ministry of Commerce favours reducing the duty and has requested the Ministry of Finance consider a cut.
Arvind Subramanian, the Finance Ministry's chief economic adviser, on Monday said "The government will have to take a broader view on what's happening in terms of gold imports, in terms of smuggling."