The government is considering a radical plan to direct commercial banks to buy gold from ordinary citizens and divert it to precious metal refiners in an attempt to curb imports and take some heat off the plunging currency.
A pilot project will be launched soon, a source familiar with the Reserve Bank of India (RBI) plans told Reuters.
India has the world's third-largest current account deficit, which is approaching nearly $90 billion, driven in a large part by appetite for gold imports in the world's biggest consumer of the metal.
With 31000 tonnes of commercially available gold in the country - worth $1.4 trillion at current prices - diverting even a fraction of that to refiners would sate domestic demand for the metal. India imported 860 tonnes of gold in 2012.
"We will start a pilot project among some banks where we will allow them to buy back gold from individual households," the source, an official familiar with the central bank's gold policymaking, said. "This will start soon, we have discussed (it) with banks."
The RBI will ask the banks to buy back jewellery, bars and coins for rupees. Lenders will have to offer better rates than pawn shops and jewellers to lure sellers.
Any talk of using the country's gold to help meet India's international obligations revives memories of a 1991 balance of payments crisis - when India flew 67 tonnes of gold to Europe as collateral for a loan to avoid a sovereign debt default.
Earlier on Thursday, Trade Minister Anand Sharma said the RBI should look into the possibility of monetising gold holdings.
It was not immediately clear whether Sharma was referring to the 557.7 tonnes of gold the RBI holds in its own reserves, or gold in private hands. He did not give more details of how the proposal would work.
"I have not said there should be any mortgaging of the gold, or auction of the gold, that is incorrect. I have just said the RBI should look into ... how they can benefit the people, particularly with regard to the bonds or the monetisation," Sharma said in response to a question in parliament.
Earlier this week in comments reported in the national media, Sharma said "even if 500 tonnes is monetised at today's value it takes care of your CAD", or current account deficit.
Selling gold reserves may sit badly with Indians, many of whom saw the 1991 sale as a public humiliation. The secret operation was only exposed after a vehicle carrying the first consignment of bullion broke down on its way to the airport from the central bank.
"It (pledging gold) will be a desperate measure, and it will send a very wrong signal to the entire country because all the time we've maintained that things are under control even though things are adverse," said Madan Sabnavis, chief economist at CARE Ratings in Mumbai.
Such a sale would also dent international gold prices which took a hit earlier this year after Cyprus said it was considering selling its gold reserves to shore up its finances.
India has taken multiple steps this year to curb imports of gold, its second-biggest import after oil, including raising duty three times to 10 percent.
The rupee, the worst-performing emerging market currency in Asia this year, rebounded from a record low on Thursday after the RBI said it will provide dollars directly to state oil companies to shore up the currency.
In comments published by The Hindu newspaper last week, David Gornall, chairman of the London Bullion Market Association, said India could raise $23 billion by swapping gold for a payable currency for a period of its choice, while remaining the long-term holder of the gold.
Gold forms an essential part of a bride's dowry in India and is considered auspicious as a gift or offering at religious festivals.