NEW DELHI – Worried Indian investors are selling gold, eroding prospects that a change of government policy in India will boost imports and underpin a fragile recovery in the price of the metal.

Although sales in India haven’t turned into a flood, domestic gold prices have weakened in the past week. The premium for gold in the domestic market relative to the international price has tumbled by almost a half to around $70 an ounce. Driving the sales are expectations that the newly elected Bharatiya Janata Party will slash import taxes and relax other controls that have created a shortage of gold, which could cause local prices to fall.

On Wednesday, India’s central bank slightly eased import rules for gold by allowing private trading companies to bring the precious metal into the country. Previously, only designated banks and state-run trading companies were allowed to import gold.

It isn’t clear whether the central bank’s decision was linked to the BJP’s election victory. Traders say they are expecting the incoming government to follow through with more significant steps.

“We are getting more sellers than buyers these days,” said Jitendra Kantilal Jain, proprietor of Jugraj Kantilal and Co., a large dealer in recycled gold in the western Indian city of Mumbai’s Zaveri Bazaar, the country’s largest gold market. “Most of these sellers are coming to offload their bars and coins, which they purchased a few months back.”

Jewelers are also purchasing only as much as they need in the short term, said Girish Choksi, a large bullion dealer in the western city of Ahmedabad. “We think that the prices will come down further,” he said.

Spot gold prices in India have slipped below 30,000 rupees per 10 grams and now are near 28,000 rupees ($476). Buying interest remains subdued.

“We have come here to sell about 20 grams of coins that we purchased last year. We don’t want to take any risk as prices are expected to fall further,” said 42-year-old Neha Shah, a Mumbai resident, as she waited inside a jewelry shop.

India, second only to China as a consumer of the precious metal, has huge amounts of gold in the hands of private and institutional investors. Investment purchases account for around 40% of India’s demand.

“There is a general sense that premiums will fall and people want to cash in before that,” said Vasu Acharya, director of Parker Bullions, which has a large distribution network in western India. “The outlook for gold [prices] is not very upbeat.”

India’s previous government, worried about a ballooning current-account deficit and in an attempt to stem a slide in the value of the rupee, made gold scarcer by raising the import tax on the metal to 10% from 2%, and ruling that 20% of all gold imports be re-exported as jewelry, coins or other finished products. The requirement about exports covers private trading companies as well as other importers.

Gold constitutes India’s second-largest import sector, ranking behind crude oil.

“Everybody is expecting an overhaul of policies,” said Mr. Acharya.

That prompts the question: If a shift in government policy causes the Indian gold price to fall to the international level, will local demand then pick up and support world prices?

International gold prices have risen to nearly $1300 an ounce so far this year, a gain of around 7%. The Ukraine-Russia crisis encouraged buying of gold, an asset seen as a safe investment in times of crisis.

Market fundamentals are starting to look rocky. The selling in India, and falling demand there, come at a time when Chinese demand for gold jewelry also is down. The two countries together account for half of global purchases, and the world gold supply rose 1% in the first quarter of this year, to 1048 metric tons, World Gold Council data issued Tuesday show.

Indian purchases of gold bars and coins collapsed 54% to 45 tons during the first quarter of 2014 from a year earlier, while January-March jewelry sales fell by 9% to 145.6 tons. A slump in the price of gold last year provoked heavy buying by bargain-hunters across Asia.

Potential Indian gold buyers haven’t responded so far to a 5.5% rise in the value of India’s rupee against the dollar since the start of January, including a gain of 2% since the election results were announced last week. The currency moves have made the precious metal cheaper in India.

“People are not comfortable investing in bars and coin, when the premiums are coming down,” said P.R. Somasundaram, managing director at the World Gold Council’s India office. The Council forecasts India’s 2014 gold demand will be between 900 and 1,000 tons, compared with 975 tons last year.

“I think it [gold] could show a huge comeback, depending on how the policy shapes up,” said Mr. Somasundaram, referring to potential moves by the new government.

– WALLSTREET JOURNAL