* Report highlights dual markets of China vs rest of world
* Without China stocks, estimated surplus lowest in nearly 20 years
* World demand, output both rise (Updating throughout)
By Chris Prentice
NEW YORK, Feb 8 (Reuters) - The U.S. government on Friday nudged higher its global cotton stockpile forecast for 2012/13 amid expectations that China, the world's largest textile market, will import even more fiber for its massive strategic supply.
In its monthly crop report, the Department of Agriculture tweaked higher its estimate for the surplus for the marketing year which ends in July by just 140,000 480-lb bales, or 0.17 percent. A whopping 2 million-bale hike in China's carryover more than offset a fall in stocks elsewhere.
The new estimate of 81.86 million bales is the sixth increase since the season began on Aug. 1 and would be 19 percent higher than the previous marketing year. It would also be the largest supply since USDA records began in 1966.
While the headline number was bearish, market participants pointed to the concentration of carryover in China, where the government holds more than half the world's supply in its strategic stockpile, and a falling surplus elsewhere.
The market is facing a record inventory this year because farmers planted record crops over the past two years to take advantage of soaring prices in 2010 and 2011. At the same time, demand from clothing manufacturers has fallen as they seek out cheaper synthetic alternatives.
As a result, Beijing's two-year buying spree for its strategic reserve has provided huge support to the market at a critical time. There is great uncertainty about how or when the government will offload the stock, which has been bought at prices almost double those for current U.S. futures contracts. Recent tenders of older stock have been sold to domestic mills.
China's carryover grabbed the most attention in Friday's report after the government increased its carryover estimate by 5 percent to 42.61 million bales.
With the country's end-user consumption rate unchanged at 35.5 million bales and its production rising 500,000 bales, market participants said the fiber would likely be held off the market in Beijing's strategic stockpile.
Excluding China, the rest of the world stockpile was cut by 1.8 million bales, or 5 percent, to 39.25 million bales. That would be the smallest surplus since the 1994/95 season, according to USDA records.
"If you look at the numbers including China, there is too much cotton. (China's reserve) may show up statistically, but it is not available for sale," said Ron Lawson, a partner at commodity investment firm LOGIC Advisors.
With the split between the falling surplus for the rest of the world and China firmly in traders' minds, cotton prices rallied to as high as 83 cents per lb on Friday.
The most-active March cotton contract on ICE Futures U.S. settled up 1.27 cents, or 1.6 percent, to 82.67 cents per lb.
There were few other major changes to the global cotton data in the monthly report.
The government raised its demand estimate by 180,000 bales to 106.2 million bales, largely due to increases in Turkey.
That reflects the ongoing shift in consumption to countries other than China. Spinning mills in Turkey, Bangladesh and Southeast Asian nations have processed more raw fiber into yarn to sell to mills in China that can use semiprocessed raw material.
Yarn can be imported duty free while raw cotton incurs a hefty 40-percent tax. There is little locally grown cotton available at low enough prices because the strategic reserve has scooped up most of this year's crop.
The USDA also increased its global output forecast by 120,000 bales to 118.95 million bales. Increases for China and Kazakhstan were mostly offset by decreases for Pakistan and Turkey.
The U.S. numbers were "friendly," cotton specialist Sharon Johnson said, noting a cut in the carryover for the world's third-largest producer and a rise in the export estimate from last month.
The government lowered its carryover by 300,000 bales, or 6 percent, to 4.5 million bales due to an increase of the same size in its export estimate to 12.5 million bales.
"300,000 bales is a pretty significant amount. That made everybody's balance sheet a little bit tighter and supported some buying," said Keith Flury, cotton analyst at Rabobank in London.
It kept its production estimate unchanged at 17.01 million bales. (Writing By Josephine Mason; Editing by Peter Galloway and Jim Marshall)