Cotton prices skyrocketed to record highs in the domestic market on expectations of higher export demand and lower supply.

On the Multi Commodity Exchange (MCX), the most active near-month futures hit its all-time high of Rs 24,200 per bale this week, while in the international market, on the benchmark Intercontinental Exchange (ICE), prices are placed at 89.44 cents per pound.

India is the leading producer of cotton in the world, followed by China and the US. As per the government's third advance estimates, Indian cotton production in 2017-18 (July-June) is estimated at 34.9 million bales, higher than last year's production of 33.9 million bales.

The demand for export requirements is predominantly bolstering the price. Amid concerns over a trade spat between the US and China, Chinese importers have now turned to India for meeting their cotton demand. Accusing China of theft of intellectual property and unfair trade practices, the US recently imposed tariffs on Chinese imports.

As a retaliatory measure, China too slapped duties on American products, which worsened their trade relations. As per reports, Chinese buyers are now entering forward deals with Indian exporters. In India, forward deals are typically signed during late July and August as the new season produce starts arriving in markets by September.

However, this year, deals were signed earlier than usual, possibly indicating higher demand. Due to a huge drawdown in cotton reserves in China, the country recently increased its cotton import quota as well.

Cotton exports from India are estimated to be around 8 million bales during the 2018-19 period, with China alone accounting for 30-40 percent. During the 2016-17 period, cotton exports from the country were 6.7 million bales. As per trade agencies' forecast, Indian cotton export to China will treble to around 1 million bales this year due to a Chinese supply shortage.

Meanwhile, as this year's normal sowing period of cotton is drawing to an end, farmers are expecting a lower yield this year on concerns over pest attack. The outbreak of pink bollworm, a pest that can cause large-scale damage to cotton plants, has been reported from many parts of major producing areas.

Weather-related vagaries led to fears on production. As per latest data released by the farm ministry, cotton sown in the country is down by 8 percent so far against the previous year. Cotton sowing is also down in all major growing states except Haryana and Tamil Nadu.

However, sowing may pick up the pace soon due to a recent hike in the minimum support price of the crop. Meanwhile, a sharp surge in MSP may presumably damage the competitive edge of Indian cotton in the global market. In July, the Government of India has raised the MSP of medium staple cotton to Rs 5,150 per quintal and for long staple cotton to Rs 5,450.

Looking ahead, an outbreak of pink bollworm in India and dry weather condition in the US, which is raising concerns over global output, may keep prices firm. The ongoing positive momentum would continue in Indian futures prices, though there are chances for an immediate correction.

Any possible fall in US cotton prices due to the ongoing trade turmoil between China and US may hit Indian prices as well. However, prevailing weakness in domestic currency is likely to support Indian exporters.

Disclaimer: The author is Head Commodity Research at Geojit Financial Services. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.