India rejected on Thursday the last-minute offer by a US collector to cancel the controversial auction of Gandhi's iconic round glasses.
James Otis told AFP he would donate the glasses, sandals and other Gandhi belongings in exchange for India boosting health spending for the poor and using the memorabilia in an international exhibition.
Otis, a California-based peace activist and documentary maker, said he would receive no money.
He said there had been a preliminary agreement during talks at the Indian consulate in New York, only hours before the auction was due to take place on Thursday at Antiquorum Auctioneers.
However, in New Delhi the junior foreign minister, Anand Sharma, appeared to reject the deal.
"Gandhi himself would not have agreed to conditions. The government of India, representing the sovereign people of this republic, cannot enter into such agreements where it involves specific areas of allocation of resources," Sharma was quoted as saying by the Press Trust of India news agency.
Sharma added that he "was sure that Otis is aware that New Delhi has policy initiatives with historic allocations of resources, particularly for rural health programs and the education of the poor, besides other pro-poor schemes."
Gandhi's family has led bitter opposition in India to the auction of what some see as the country's national heritage.
The collapse of the deal may force India to bid for the items, which also include a pocket watch and a bowl and plate.
The auction was set for Thursday at about 3:30 pm (2030 GMT) at Antiquorum Auctioneers in New York.
Earlier on Thursday, the government said it would do "whatever it takes" to prevent the auction.
"I have the prime minister's instructions that we would not like to have these items be auctioned from one party to another," Indian Culture Minister Ambika Soni told NDTV.
"We will enter the auction if required as a last resort," she was quoted as saying by the Press Trust of India.
Antiquorum has put an estimate of $20,000 to $30,000 on the items, which will sell as a single lot. The final price could be substantially higher, in part because the row over sale has created worldwide publicity.
Soni told reporters that "the bottom line is to procure the memorabilia."
Otis said his proposed deal would have required India to "substantially increase the proportion of the Indian government budget spent on health care for the poor during the next decade."
Also, India would promote events in 78 countries -- one for each of Gandhi's years alive -- "to promote Gandhian non-violent resistance" and "encourage the study of Gandhian nonviolence."
"With that, the auction is called off," Otis said.
Otis said he had a lawyer ready to go to Antiquorum and retrieve the items.
Mahatma Gandhi was famous for rejecting material possessions. He led India's peaceful independence movement against British rule and was assassinated in New Delhi by a Hindu fanatic in 1948.