* Sugar prices drop 13 pct since the start of season
* Mills input costs gone up as govt raises cane price
* Sugar prices to stay under pressure on bumper output
MUMBAI, Jan 17 (Reuters) - Indian sugar processors have undermined their own margins in order to meet government mandates on when to pay cane farmers, which required them to sell supply onto the market at the same time they agreed to pay more for sugar cane.
India, the world's second-biggest sugar producer, requires the processors to pay cane farmers within two weeks of harvest. The mills agreed in May to pay the farmers 11 percent more for their cane for the 2017/18 marketing year, which started on Oct. 1.
Many mills struggled to raise funds from local banks to make the payments, said a senior official at the Sahyadri co-operative sugar factory based in the western state of Maharashtra.
This has caused some mills to have fallen behind on the payments by an estimated 20 billion rupees ($312 million), said a government official who declined to be named.
To meet the funding shortfall, mills boosted sugar sales which has caused the refined sugar market <SUG-ARMKHP-NCX> to drop by 13.1 percent to 3,189.50 rupees ($49.77) per 100 kg.
"The liquidity crunch forced a few mills to make distress sales. Sensing mills problems, traders also tried to bring down prices," said B.B. Thombre, president of the Western India Sugar Mills Association (WISMA).
The rapid decline in sugar prices means margins in the current year are likely to be lower than the previous year, said Narendra Murkumbi, managing director of Shree Renuka Sugars , the country's biggest refiner.
The mills agreed to pay the higher cane prices expecting stable refined sugar prices, but have been caught out by the slump.
The fall could slash profits for companies like Balrampur Chini Mills Ltd, Shree Renuka, Dwarikesh Sugar Industries and Simbhaoli Sugars by at least 15 percent from a year ago, said a Mumbai-based sector analyst with a brokerage.
"Mills raw material cost has gone up, but prices of the finished product, sugar, are falling," said the analyst, who was not authorized to speak to media.
Simbhaoli Sugars said "it is difficult to comment on margins now," while Dwarikesh and Balrampur declined to comment, citing regulations that limit communications before quarterly results, due in the next few weeks.
Sugar prices may remain under pressure as the country's sugar output in the next season could rise above the record 28.3 million tonnes produced in 2014/15, said Ashok Jain, president of the Bombay Sugar Merchants Association.
"It is now difficult to pay the assured price to farmers unless government intervenes to support prices," said WISMA's Thombre.
The central government fixes the price that mills must pay growers annually, but some cane growing areas, especially the state of Uttar Pradesh, raise the price further to satisfy the demands of cane growers, a key voting bloc.
($1 = 64.09 Indian rupees)
(Reporting by Rajendra Jadhav; Editing by Christian Schmollinger)