SHANGHAI, Jul 01, 2011 (Dow Jones Commodities News via Comtex) -- With an increasing number of trading companies moving bonded copper into the domestic market as a means to raise short-term funds, copper supply in China has been on the rise, pushing down prices in the process.

Spot copper was trading at a discount of CNY250-CNY300/ton against Shanghai Futures Exchange July copper contract Friday, compared with a premium of CNY200-CNY400/ton just last week, reflecting the sharp decline in buying interest amid increasing domestic supply.

With domestic credit market conditions tight and facing intense cash flow problems because of mid-year payment requirements, Chinese companies are buying dollar-dinominated copper held in Chinese bonded warehouses against letters of credit from banks, paying the import duty and selling the copper in the domestic market even at a loss, to raise short-term credit, industry participants said.

This allows the sellers to divert funds raised from the sale of copper, to other uses, until the LCs become due for payment in about six months. Rising demand for bonded copper has pushed up the premiums on such deals to $130/ton this week, from about $100/ton at the start of June.

With more bonded copper moving into the domestic market, stocks in bonded warehouses have dropped to 300,000 to 400,000 tons this week, from about 500,000 tons in early June, traders said.

Tight credit conditions imposed by the government to fight inflation have limited borrowers' ability to secure credit lines, and that is driving such trades, market participants said. Since October last year, Beijing has raised banks' reserve requirement ratio nine times and the benchmark interest rate four times. The latest RRR hike was announced after inflation hit a 34-month high of 5.5% in May.

The practice of moving copper to the domestic market and using the proceeds for short-term financing needs has increased in recent weeks after fabricators also started buying copper from bonded warehouses, traders said.

Chinese firms are usually required to make loan payments before the end of June, causing a short-term cash squeeze, but Beijing's ongoing monetary tightening has made the problem more severe this year.

"Companies have more pressure in terms of cash flow by mid-year, and given the monetary tightening this year, we've started some purchases of bonded copper just to level off such pressure," said a manager at a large fabricator in Jiangsu province. "The (monetary) tightening really affects the entire industry chain, and the cash flow problem we have is mainly due to late payment from our clients."

Traders said the majority of bonded copper buyers are not regular participants in the physical market, but those using the route just to raise short-term funds.

"Non-industry participants are still the main stream because they're desperate to get the cash. As long as they can shoulder the losses incurred during customs clearance, they'll just go for it," said a trader with a domestic house that trades around 300,000 tons of dollar-denominated copper a year.