* Aggressive stockpiling scheme has hurt textile mills

* China sold 2.5 mln T of cotton from reserves this yr -assn

* Cotton production seen down 5 pct this year -assn (Updating to add U.S. comment, prices in paragraphs 10, 14-18)

By Dominique Patton

QINGDAO, China, June 7 (Reuters) - China, the world's largest cotton importer, is considering changes to its aggressive stockpiling program, which has driven up global prices and forced the country's textile mills that buy fiber to make shirts and pants into heavy losses, industry official said on Friday.

In a bid to protect the rural economy, Beijing has bought some 10 million tonnes of cotton from local farmers at above-market prices under the stockpiling programme, keeping domestic cotton prices as much as 40 percent higher than the global benchmark.

But the government, along with the country's cotton association, has acknowledged the policy has hit domestic textile firms hard, with expensive cotton at home pushing up costs and eroding their competitiveness with exporters in other countries, causing some firms to cut production or shut down.

"It was not our intention (to impact mills in this way) when we formulated the policy ... We didn't expect it would be implemented for so long," Gao Fang, vice president of the China Cotton Association, said on the second day of an industry conference.

"We have reached a consensus that we need a better policy for the Chinese market."

The outlook for the programme is a key factor in global cotton markets, as China at one stage held about 60 percent of the world's cotton stocks in its reserves.

The government is considering ways to reduce the price distortion caused by stockpiling, Liu Xiaonan, an official from the National Development and Reform Commission, China's powerful economic planning agency, said at the event on Thursday.

"The cotton policy has weakened the role of the market ... We have to look at this issue. The current cotton policy has room for improvement," Liu said, adding that the State Council was considering the issue.

Liu did not give details on how the policy could be revised and the government has previously said it would continue its stockpiling policy for the 2013/14 marketing year, buying domestic cotton at 20,400 yuan ($3,300) per tonne.

That compares with a price on U.S. ICE Futures of 84.73 cents per lb, which equates to $1,867 per tonne.

"The price pressure on textile factories is huge," said Li Ming Ge, general manager of Henan Huapeng Group, a mid-sized mill.

"The gap with foreign cotton is 3,000 to 4,000 yuan per tonne. We can get import quotas; one tonne for every three tonnes of local cotton, but it's not a big help."

Beijing restricts imports of cotton via a quota system for textile mills.

While there were few details of the possible overhaul, the chance that Beijing may rein in its years-long buying spree spooked traders in the United States, the world's No. 1 exporter.

The stockpiling contributed to cotton's months-long rally two years ago when prices touched 2.20 per lb in March 2011 for the first time since the U.S. Civil War. That surge damaged textile mills and clothes manufacturers' profits.

"Clearly, they don't have a good exit strategy, which will keep everyone nervous," one U.S. broker said.

State buying has elevated prices on the U.S. exchange, which is used as the benchmark for global trade, to levels unjustified by fundamentals, traders say. The hoarding also created a perception of tightening supplies even as the market faces a record surplus in the 2012/13 season.

Far forward prices, representing the 2013/14 crop and likely affected by any change in policy, fell on Friday after the news. Prices for delivery in December settled down 0.43 percent at 85.02 cents per lb.

DIRECT SUBSIDIES?

Industry participants said talk of a change in the cotton policy has intensified over the past month as Beijing reflects on what to do with its bulging stockpile, most of which contains older fiber that mills typically shun.

"There's no way they can keep stockpiling," said Ma Jun, cotton analyst at Founder Commodities. "There's nowhere to put the cotton, the warehouses are full."

Industry sources said the government may give farmers subsidies directly, instead of supporting producers through stockpiling.

"I think they will announce a new support mechanism for farmers before the end of the year," said Ma.

China has sold 2.5 million tonnes of the fiber so far in the current marketing year, the cotton association said. The government has said it plans to sell a total of 4.5 million tonnes by the end of July.

Although traders had feared the inflow of state stocks could curb imports, the association said imports of the fiber that paid full taxes had jumped by nearly seven times from a year ago to 757,000 tonnes by April.

Meanwhile, Gao said China's production is seen at 6.5 million tonnes this year, down about 5 percent from year ago as farmers reduce planting of the fiber on slower demand from textile mills. Consumption is seen at about 8.5 million tonnes.

($1 = 6.1362 Chinese yuan)