As the price of food products continues to rise, many Chinese are feeling a pinch in their pocketbooks. Inflation worries have been spurred by the recent surge in the consumer price index (CPI), which rose 5.6 percent in July compared to the same time last year, according to the National Bureau of Statistics (NBS). This great leap upward, 0.6 over the inflationary warning mark of 5 percent, has triggered inflation jitters around China.

Earlier in the year, the People's Bank of China stipulated that a 3-percent CPI rise would be the marker for potential inflation. Continuous levels above 3 percent--May's rise of 3.2 percent and June's rise of 4.4 percent--have pushed the central bank to take action. However, raising the interest rate and the reserve requirement ratio has done little to slow down the galloping CPI, a leading indicator of inflation.

Year of the pig

Yao Jingyuan, NBS Chief Economist, said the rise in consumer prices was structural and that food prices were the major cause of the CPI jump. NBS statistics show that food prices rose 15.4 percent in July year on year, 4.1 percentage points more than June and 7.1 percentage points higher than May. Prices for non-food products, on the other hand, rose only 0.9 percent in July.

Yao said the biggest factor for the rise is the skyrocketing price of pork, costs of which have expanded to other agricultural products, processed foods and the catering industry, lifting the overall boat on which food prices float. It is widely expected that CPI increase in the third quarter will be higher than that of the first half of this year.

What is paramount now, according to experts, is that industrial products remain uninfluenced by rising food prices. Once the prices of industrial products increase significantly, inflation becomes unavoidable. It is fair warning that the central bank's second-quarter China Monetary Policy Report issued on August 8 has already seen small moves in this direction. "The price increase of grains, meat and egg has already expanded to the lower reaches of the food processing and catering industries," said the statement.

The good news though was that the growth rate of producer price index (PPI) has remained low. PPI only rose 2.4 percent year on year in July, a 0.1-percentage-point slip from June.

Whether the PPI will remain at that level is difficult to predict. Tao Dong, Chief Economist of the Asia-Pacific region with Credit Swiss First Boston, believes food prices will increase further. Chinese corn and soybeans are greatly dependent on imports and rising international agricultural prices will further accelerate these costs, ultimately affecting domestic prices. In the background, the connection between Chinese wheat and rice prices and the international market is tightening.

Looking ahead to this fall's grain production, one fourth of the 73 million hectares of farmland has suffered from serious flooding or drought. Although summer grain harvests grew 1.9 percent year on year, if the autumn gain output--which accounts for 80 percent of the total grain output for the whole year--fails to grow, food prices will not be reduced.

Tao believes that increases in salaries and rent are also major contributors to the rise in consumer prices.

Pork reserve politics

The Chinese State Council issued an emergency notice on the evening of August 13 ordering all related departments to take concrete measures to bring production and supply of non-staple food into line. The notice said the significant increase in consumer price has become a major problem for macroeconomic development.

The Chinese Ministry of Commerce and the Ministry of Finance also jointly issued management measures relating to the central meat reserve, stating that if meat prices do not stabilize by September 15, meat reserves could be released as part of an emergency measure.

The rules authorize the Ministry of Commerce to release the central meat reserve after consulting with the Ministry of Finance in times of large price fluctuations due to serious natural disasters or public health emergencies. The two ministries will also work out a plan for determining the amount, category and price of meat released as well as how to distribute it.

The management measures stipulate that the Chinese Agricultural Development Bank is responsible for providing loan support for the government, supervising the reserve meat loans and safeguarding price security. The Ministry of Finance is in charge of financial administration of the reserve meat and deploying and managing reserve meat subsidies. The Ministry of Commerce is responsible for the administration of reserve meat and approval of the quality of meat processing companies.

The Chinese Government also took measures to prevent the price hike of food-related products. On August 6, the National Development and Reform Commission (NDRC) ordered consumer price supervisory departments at all levels to monitor food manufacturing, wholesaling and retailing enterprises and punish illegal price manipulation activities.

Local governments have also taken more strict measures regarding the price problem. South China's Guangdong Province announced that companies which manipulate the market price or spread rumors about price increases will be punished, and their illegal gains will be confiscated, and other punishments will also be exercised.

The sky isn't falling

While rising food prices may have some worried about inflation, others aren't as dire in their prognostications. A report from Development Research Center (DRC) of the State Council argues that the consumer price increase is structural and conditions are not ripe for large-scale increases in the cost of commodities.

The DRC report stated that although investment, consumption and exports were growing rapidly on the shoulders of increasing domestic and international demands, the supply growth potential of the non-agricultural sector is even stronger. Meanwhile, companies now can react to market demands more quickly, helping guarantee immediate supply.

Even though the July CPI growth was the highest in a decade, non-food price indexes within CPI were relatively stable--only rising 0.9 percent year on year. The DRC report contends that commodity prices will not continually surge but will level out gradually.

Fan Jianping, Director of the Department of Economic Prediction under the State Information Center, said that the rise in food prices will not spread to other sectors or cause serious inflation. Fan said the divergent paths taken by the CPI and PPI indicate that food prices are not impacting producer prices, lending credence to the idea that the rise in food prices is merely structural.

Currently, there is an overcapacity of industrial goods, meaning their prices will not immediately rise and inflation should be held down. Lu Zhongyuan, Director of the Macroeconomic Research Institute of the DRC, estimated that the CPI growth rate will slow due to government measures taken to control the food prices. Lu said the autumn grain harvest will help bring food prices back to normal.

Sun Mingchun, Chief Economist with Lehman Brothers Asia, also said the 5.6-percent CPI growth exceeded his firm's estimations. Sun stated that there was no clear sign that food prices would be passed on to non-food sectors.

"With the measures taking effect in the second half of this year, the rapid food price increases will be controlled effectively, and the CPI for the whole year is expected to be under 4 percent," said Yao Jingyuan.