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By Dominique Patton and Niu Shuping
BEIJING (Reuters) - China is preparing the ground to scrap a controversial scheme to stockpile cotton in favor of subsidizing farmers, a move that could slash imports by the world's top buyer of the fiber and herald a broad shakeup of Beijing's sensitive farm policies.
Abandoning stockpiling would mark the end of a system that has distorted the market to such a degree that it has been cheaper for Chinese mills to import cotton grown abroad than to buy domestic produce.
China's top economic planning body has completed a draft plan to change to subsidies and is seeking opinion from experts and the industry, people involved in the discussions told Reuters. This could within months set in course a policy change.
With 60 percent of world cotton stocks held in Chinese state reserves, changes to a scheme that has cost at least $33 billion so far, based on estimated payments over the last two years, could hit prices hard.
Global prices have climbed 13 percent since the start of the year, but could reverse as Chinese mills would be able to buy more locally grown cotton freed up for the local market.
The reform could also stoke calls to shift to subsidies for growers of other commodities such as sugar and oilseeds, with China's sugar association already considering a switch.
China would continue to buy for strategic food reserves in case of emergency, however.
"All parties are working to change the (cotton) policy," said Du Min, director of the Research Center for Rural Economy at the Ministry of Agriculture.
"Farmers are not planting cotton anymore, while mills are no longer spinning (domestic) cotton. The stockpiling has to come to a stop, otherwise the whole industry chain will be ruined."
It could take several months to finalize the structure of any subsidies, which would probably be applied in the crop year that starts in September 2014.
China views the financial support of its 700 million farmers as crucial for both its food supply and political stability, particularly in regions with large ethnic minorities such as Xinjiang, its main cotton-producing area, and southern Guangxi and Yunnan, the principal sugar provinces.
But pressure has been building from all sides to end stockpiling, under which the government buys up most of the domestic crop at above-market prices.
Textile mills have been fierce critics of the scheme that started in 2011, as a complex quota system means their access to overseas markets can be limited, forcing them to either curb production or buy at high prices from the national reserves.
China's finance ministry, facing a massive bill for the 10-million tonne stockpile, is also strongly opposed to an increasing reserve, industry sources said.
And rising costs, especially for fertilizer and labor, mean that growing cotton has become less attractive even with the high prices guaranteed by the stockpiling scheme. Farmers have been switching land to other crops such as wheat, with a preliminary survey by the China Cotton Association showing that acreage this year is expected to be the lowest in a decade.
Any release of cotton stocks from reserves in the wake of a shift would also hurt global prices.
"A one million-tonne release could crush prices to as low as 30 cents," said a U.S. trader. The December cotton contract on ICE is currently around 84 cents per pound.
Among alternatives being considered by China's top economic planner, the National Development and Reform Commission (NDRC), is using a so-called target purchase price, an idea first touted in a 2008 government food security plan. Beijing would supplement farmers' incomes if market prices dropped below a reference price, similar to a policy long-applied in the United States.
The reference price could be based on international market prices but should also take into account domestic grain purchasing prices, believes Du, to ensure the nation's farmers are treated fairly across the board. Cotton should be 8.5 times higher than the grain price because of its higher labor costs, she said.
Subsidizing farmers directly instead of purchasing at a high minimum price would allow domestic cotton prices to fall close to the current international level of roughly 13,000 yuan per tonne, said Thomas Reinhart, head of sourcing in the China unit of cotton trader Reinhart. That compares to prices as high as 20,790 yuan per tonne offered by the state reserves.
"This would be very beneficial for the Chinese textile industry and certainly lead to improved consumption, bringing supply and demand back in balance," he said.
But some say subsidies carry their own risks.
"How can the government ensure that the subsidies go to farmers? Unlike big farmers in the U.S., Chinese farmers are all small and isolated. The direct subsidy policy could lead to local corruption and falsifying production figures to get more subsidies," said Wei Linyan, a senior analyst at textile industry portal www.sinotex.cn.
China has been plagued by a series of high-profile corruption scandals such as the case of Bo Xilai, once a rising political star who is now awaiting a verdict on charges of corruption, bribery and abuse of power.
Still, the China Sugar Association is pushing for its sector to be next on the list for reform, saying this month that it has started research into the benefits of direct subsidies. Analysts say state sugar reserves currently stand at around 6 million tonnes, about 60 percent of the global total.
Chatter in the oilseeds market suggests participants are also eager for an end to a stockpiling program that has only seen local production sharply drop.
But it could take several years before Beijing risks deviating from its current support program for strategic food crops like wheat and corn.
"The major concern is grain security. Cotton is different," said Zhong Funing, a professor at Nanjing Agricultural University.
"Direct subsidies (for grains) would not stabilize prices in the short term and for more than 10 million farms in the northeast, growing grain is their only choice." ($1 = 6.1246 yuan)
(Additional reporting by Josephine Mason in New York; Editing by Joseph Radford)