White sugar for March 2007 delivery fell to its daily limit of 4 per cent on the Zhengzhou Commodity Exchange, down CNY178 (US$22) to close at CNY4,265 (US$533) a ton.
Prices for domestic sugar reached an all-time high earlier this year, following a drought in the southern provinces of Yunnan and Hainan that reduced this year's output by 3.9 per cent to 8.82 million tons, according to Ministry of Commerce figures.
The area planted with sugar crops also decreased by about 80 square kilometers last year.
However China's sugar consumption is rising, from 10.5 million tons of white sugar in 2004 to 10.8 million tons in 2005, and it is expected to be higher again this year.
Summer is expected to bring stronger demand for sugar from beverage makers, prompting the government to release some of its reserves.
The sugar will be auctioned over the next four months, according to a joint statement issued by the Ministry of Commerce, the Ministry of Finance and the country's top economic planning body, the National Development and Reform Commission.
At least 92,000 tons from the state reserve will be auctioned each month, starting on 27 June, and additional sugar from Cuba will also be sold after it has been processed in China.
All of the sugar will be priced at a minimum CNY3,800 (US$474.75, €376.49) per ton.
China has already auctioned 460,000 tons of white sugar this year, and had promised to release 1 million tons in total from its stocks. It is not clear whether the country will be left with any further sugar in reserve.
Hu Zhijiang, deputy chairman of the China Sugar Association, said he is not sure whether national stockpiles of sugar have been used up, although the government also released 1.06 million tons of sugar in 2001 to stabilize prices.
"If the national reserves are used up before the new sugar production season in October, China will have to import more from abroad," he told AP-Foodtechnology.com.
A recent report has predicted that China will become one of the world's largest importers of sugar, reaching up to 2.0 million metric tons by 2011 and 3.5 million tons by 2015.
The International Sugar Organization report said that China's sugar consumption will grow at a rate "significantly higher than the world average" and that its domestic sugar industry is "not expected to be able to meet the projected growth in sugar use".
"Our projections imply that there will be a need for an additional 4 million tons of sugar due to demand growth by 2015 as against 2005," the ISO said.
China is currently the world's third largest producer and the second largest consumer of sugar after India.
However the ISO says that China's domestic sugar prices are currently attractive for domestic producers, amid stronger world prices, which should help boost output. This means if normal growing conditions occur, domestic production will likely come close to increases in consumption in the next two years.
"There is a strong probability that China's import demand will fall below 1 million tons in 2007 and 2008," ISO said.