The Central Government may implement price controls on daily necessities at the retail level if food inflation gets out of control.

In 2008, price control measures were imposed on daily necessities at the retail level, and major players in the mass market food and beverage industries were affected.

We have repeatedly said that inflationary pressure is a clear and present danger for China, after rising to a staggering 4.4 percent in October and showing no sign of easing. The Central Government is taking it seriously and has unveiled a blue-print to tackle the core problem: soaring food prices.

In a recent State Council meeting aimed at stabilizing consumer prices, leaders made it clear that the government will provide more support to agricultural production and strive to increase vegetable supply.

It will also use the national reserves of grain, edible oil and sugar as well as enhance the monitoring and regulation of speculation in the agricultural futures market to stabilize related product prices.

The cabinet also declared that the government could temporarily intervene in the pricing of basic consumer goods and producer goods when necessary. To lower production costs, the Central Government will cancel various administrative fees and trim collections in a number of sectors, including transportation.

The cabinet also vowed to provide more subsidies to low-income households to alleviate the negative impact of inflation.

Officials indicated that domestic inflationary pressure has intensified significantly in recent months. Although the measures announced at the cabinet meeting might have some impact on price expectations, they can hardly alter the fundamental factors surrounding the supply and demand situation - especially considering the special production cycles of most agricultural products.

As the supply shortage will persist until at least through the end of the winter and demand is set to increase around the traditional Spring Festival season, the growth of consumer prices, especially food, looks sure to continue for at least the next few months. This suggests that the central bank will very likely raise its base rate again by year-end.

Last week, the Central Government announced moves to stabilize consumer prices, which included: 1) developing the agricultural sector to increase production; 2) stabilizing agro-product supply by releasing state reserves and ensuring smooth transportation/distribution; 3) waiving toll fees for the transport of fresh agro-products and lowering the entrance fee in the wholesale markets and supermarkets; 4) possible price control measures on daily necessities and production materials; 5) curbing "abnormal" trading to prevent price manipulation and other activities that may disrupt the market; and 6) increasing punishments for speculators in agro-products.

The above measures are just a framework. But we believe the Central Government will implement some of these measures when the situation warrants, given its serious attention to the inflation problem. And how these measures are carried out will have significant implications to players in related sectors.

The crux of the food inflation issue includes the production shortfall of certain agro-products due to adverse weather, rising costs (labor, energy and transportation), the weak US dollar and stocking up in the distribution channel. It is difficult to solve the first three problems; therefore, most of the measures mentioned above aim at increasing supply, ensuring smooth distribution, as well as stopping excessive speculation on agro-products and lowering intermediate costs. Lowering entrance fees for wholesale markets and supermarkets - a new measure - serves this purpose. Meanwhile, the imposition of price controls will be the last resort because it could potentially reduces supply as some producers may quit. We believe price controls will only be imposed on daily necessities whereas companies facing cost pressures will still be allowed to hike prices, albeit gradually.

Peter Pak is executive director of BOCI Research Limited. The opinions expressed here are entirely his own and do not represent BOCI or any other affiliated companies within the group. Nothing in this article constitutes an investment recommendation.

(HK Edition 12/10/2010 page2)