UPDATE 2-China mulls cotton imports, stock sale to placate mills

Fri Jan 4, 2013 6:18pm EST

* Proposal would require mills to buy state reserves - sources

* Beijing's stockpile equates to over a third of global annual output

* Move seen tackling mills' problems of tight supplies (Adds background in paragraphs 3-6)

By Niu Shuping and Josephine Mason

BEIJING/NEW YORK, Jan 4 (Reuters) - China, the world's biggest cotton consumer and importer, is considering issuing fresh import quotas and selling some of its massive cotton stockpile in a move merchants and analysts say is aimed at heading off a potential crisis in the world's largest textile industry.

The much-anticipated proposal, which allows spinning mills to buy more foreign raw cotton, is still under consideration, said sources who declined to be identified as they were not authorized to talk to the media. But if approved, the quotas will require mills to buy three tonnes of cotton from state reserves for every tonne they import, they said.

On Dec. 28, top planning agency, the National Development and Reform Commission (NDRC), said in a statement it would auction off an unspecified amount of cotton from its record-sized reserve but gave no further details.

Beijing has been building a strategic stockpile of cotton since 2011 with the aim of supporting farmers, who are considered crucial to feed the country's growing urban population.

But while helping growers, the policy has hurt China's textile mills, sucking supplies out of the domestic market and forcing them to rely on imports.

Combining an auction of state reserves with fresh imports resolves two issues facing the government: after its two-year buying spree, it can offload some older stock while offering much-needed respite to the country's spinning mills, which have struggled with tight domestic supplies and high local prices.

"It is (a) compromise by the government to help quieten down complaints by textile mills," said Jian Jinglei, an analyst with Shanghai CIFCO Futures.

By March, Beijing is expected to have accumulated some 8.6 million tonnes of fibers, enough to supply China's mills with raw material for a year. That also equates to more than a third of global 2012/13 output.

"They've helped the farmers out. They now have to make sure the mills have a chance to remain competitive," said Peter Egli, director of risk management for Plexus Cotton Ltd, a UK-based medium-sized merchant which does business in China.

"(The government) has to let stocks go or imports come in or a combination of both, which is what is rumored," he said.

It is not clear if the new imports quotas would be a duty free basis or on a sliding tariff system, but foreign prices are about 20 percent cheaper than local fibers, merchants say.

Last year, China issued import quotas for more than 3.7 million tonnes at sliding tariffs of 5-40 percent.

AUCTION AND IMPORTS SOLVE GROWING PROBLEM

The proposals come after months of speculation about how Beijing would solve the problems caused by the stockpiling.

During the latest harvest in 2012, the reserve scooped up an estimated 75 percent of the country's 6.9-million-tonne crop, forking out as much as 18,500-19,000 yuan per tonne. That was on top of its massive purchases in 2011.

That equates to about $1.35 per lb, about 20 percent more than it typically costs mills to import foreign fibers. It is also double the benchmark price on ICE Futures U.S.

Only a limited number of mills, however, are allocated import quotas, which means the majority have to pay expensive domestic prices, making them uncompetitive.

Companies that can import cotton also often sell their purchases to other mills at a huge profit, adding to the cost burden for textile mills. Integrated mills also buy yarn, a semi-processed product that doesn't incur a duty, as an alternative.

China's cotton imports in the first 11 months of the year 2012 jumped 79 percent compared to the previous year to a record 4.6 million tonnes.

BEARISH FOR PRICES

News that the state would release some of its hoard struck at the heart of many U.S. merchants' fears about how long the government's stockpiling would last. It is not clear if the government will replenish its stocks after the auction.

The reserve policy has been a key prop to the market while mill consumption has flatlined.

"It's hard to see the positive in this. They've been nothing but buyers for so long," said a U.S.-based broker.

Any increase in imports could boost U.S. cotton though, as the United States is the largest exporter of the fiber to China. Bulls also took comfort on the expectation that any auction will likely be minor compared with the overall size of the hoard.

"What matters in the long run is that imports are likely to continue, albeit at a reduced rate," said Egli. ($1 = 6.2303 yuan) (Editing by Miral Fahmy and Kenneth Barry)

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