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China prepares to unravel its cotton stockpile

Stringer | AFP/Getty Images

China is to start selling down its bloated state cotton reserves on Thursday, in an anticipated move that has already caused prices on global markets to unravel.

Chines estate cotton reserves stand at about 10m tons – or half the world total – after a three-year buying binge that lifted international prices. The China National Cotton Reserve Corp is caught in a dilemma, as any attempt to cut its position is likely to further pressure prices and result in steep losses.

(Read more: Cotton prices tumble to 10-month low on China concerns)

The auction, announced by China National Cotton Exchange on Wednesday, will be closely watched by global markets for clues to the fate of the massive cotton stocks that are baled up in its warehouses.

Spot cotton prices on ICE have dropped steadily in recent months in anticipation of sales from the Chinese reserves.

The floor price at Thursday's auction is likely to be set at 18,000 yuan a tonne, well below the 20,400 yuan per tonne price at which the reserve body bought cotton this harvest season, industry executives said. The sales price is roughly equivalent to the cost of importing cotton.

(Read more: China prepares to ditch cotton stockpiling, wider reform looms)

In an effort to encourage farmers to plant cotton, China bought cotton at above-market prices – a policy that backfired by diverting raw materials away from textile mills, who turned in desperation to importing cotton yarn. Meanwhile, the more it bought the bigger the potential losses faced by the reserves body tasked with buying cotton.

China's state planning body, the National Development and Reform Commission, in October finally stepped in to untangle the situation, arousing market expectations that reserves would be reduced.

Industry executives said the amount sold on Thursday would depend on the quality and the willingness of textile mills to buy "old" cotton that has been warehoused for more than a year. Auction rules limit the volume of purchases by individual mills, in an attempt to prevent hoarding and subsequent resale.

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