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Many factors are affecting the consumer price levels in 2006, among which the resource price reform has a decisive impact on the consumer price index (CPI) control.

Tight supply of energy resources, price reform on such resources as oil, power, water, gas, coal and land as well as the increased labor costs tend to push prices up this year. But at the same time, oversupply of most consumer products, stable grain prices, overcapacity in some industries, low increase of bank loans and rising imports due to reduced tariffs, will certainly drive the consumer prices down.

Summing up the above factors, experts generally think that the consumer price index will drop this year.

But in his report on the work of the government last month, Premier Wen Jiabao pointed out that the rise in consumer prices should be kept under 3 percent.

Compared with the 1.8 percent increase in 2005, the target has left quite some leeway. The introduction of the new weight system in the CPI calculation is probably the major reason for setting such a goal.

In the old weight system, food accounts for 33.6 percent, non-food price and service price were 22 and 44 percent respectively. The weight of real estate, education cost and expense of medical treatment were low, and the consumption of energy had no direct weight, which does not fit the current consumption tendencies and cannot reflect the real price changes.

The National Bureau of Statistics has made a regular adjustment on the CPI weight system. The weight of food products decreases while that of energy, housing and services increases. Therefore, the CPI increase will possibly be higher than our expectation and a 3 percent increase is a rather practical task.

Among all the factors, the price reform on resources is the most important and most unpredictable one, which has a decisive impact on the CPI control. Government departments should be cautious in reforming the pricing system of resources.

First, a market competition mechanism should be introduced.

To prevent monopoly enterprises from using the reform as a pretext to constantly increase resource prices, resource suppliers should be diversified. Non-government capital should be encouraged to enter. Government supervision should also be strengthened. 

Second, the reform on resource prices should be carried out in a gradual and differentiated way.

The social and economic conditions for an overall marketization reform are not mature yet. An all-round reform will possibly hamper macroeconomic control. A complete liberalization of resource prices will directly increase prices of resource products. And that will lead to an investment craze in the upper reaches and increase of production cost in the lower reaches. Price hikes of lower reach products will most likely lead to inflation. The public's living costs will increase, too, which will reduce the total demand level and lower consumers' actual living standard. China's export will also be affected.

Thus, the reform on resource prices should take a classified and measured process. The resource departments should firstly introduce competition to improve their production efficiency.

Third, the reform cost of resource prices should be shouldered fairly.

The resource prices were low in the past due to administrative control. Low resource prices had led to overcapacity in industries, bad debts in banks and the extensive expansion of the economy, which have cast a heavy burden on the whole society. Such a cost is carried mainly by the government and the public.

Once the product prices get raised, the public's living cost will increase. The industries of lower reaches will be affected too. Their production costs will increase and profits will drop.

Profits from increased resource prices, therefore, should not be fully enjoyed by monopoly enterprises. Instead, they should shoulder some cost of the reform with low-reach industries and the public.

Fourth, the reform of resource prices should be carried out with other co-ordinated reforms.

Resource products almost cover all basic living materials. Social security and welfare system should be improved to guarantee low-income earners' living levels.

Resource enterprises' property relations should be straightened out. Inexplicit ownership and poorly defined right and responsibility will increase the transaction costs.

The financial and taxation system should be reformed. Production that causes pollution should be taxed. Taxation concerning environmental protection should be enhanced to let resource prices reflect the pollution-control cost. The central government should give part of the taxation income back to the local government for their pollution control work.

Fifth, in the reform, a few extremes should be avoided.

In China, many resource industries are monopolized by State-owned enterprises, which also bear the responsibility of national resource security. They have the double nature of being both enterprise and a country's basic product supplier. In the resource price reform, when the market situation is in their favor, resource monopoly enterprises tend to use the market for higher profits and overlook their social responsibility. But when they meet competition and the resource prices decline, they probably will use their monopoly capacity to protect their own interests and act as an administrator. Such a situation should be prevented.

Government macro control should go on to protect public interests in the reform. China's resource market is still at the primary stage of development. The resource industries should be strictly supervised by the government. When the situation is not mature, excessive marketization of the resource prices should be shunned.

What the reform targets is the price-forming mechanism to promote competition in the market. It should not be carried out only by adjusting prices by resource suppliers. Otherwise it will enter the vicious circle of price hiking and harm public interests and the functioning of the national economy.

The author works with the China Price Monitoring Centre under the National Development and Reform Commission.

(China Daily April 7, 2006)