• Mainland China's consumer price inflation eased markedly in May to 7.7% from 8.5% in April due to slower growth of food prices. But soaring world oil prices have forced the authorities to raise domestic gasoline and diesel prices sharply.
  
  
• The immediate impact of the oil price hike on the economy is limited given the various relieving measures accompanying the price change. Consumer price inflation is unlikely to rise by more than 0.5 percentage point as a result.
  
  
• But if world oil prices continue to soar, domestic oil prices could rise again, raising pressure on inflation and dampening economic growth. After the latest adjustment, oil prices in mainland China are still some 20 to 40% lower than world levels under the government's oil price control.
  
  
• In the first five months of this year, mainland China's economy was still growing impressively. But slowing global demand means that the Mainland's growth engine could lose momentum. Economic growth would moderate even more if world oil prices soar further.

Mainland China's consumer price inflation dropped quite markedly to 7.7% in May from 8.5% in April and 8.7% back in February due to slower growth of food prices, raising hope that food price inflation, the major source of inflation pressure so far, may be near its peak. In the first five months, consumer price inflation still averaged 8.1%. Even if food price inflation does ease, however, high world oil prices mean that inflation may stay high for a longer period.

Oil prices raised

On 20 June 2008, mainland China unexpectedly raised the wholesale prices of gasoline and diesel by 17% and 18% respectively, the first increase since October 2007. With retail prices being permitted to increase by another 8% maximum, the retail prices of gasoline and diesel could rise by up to 25%. The authorities also raised the price of electricity for commercial use by an average of 4.7%, effective 1 July 2008.

Presently, mainland China had to import about half of its oil needs from the world market, but the authorities have been extremely cautious in raising domestic oil prices for fear of aggravating inflationary pressure. Since January 2007, world oil prices have risen by some 115% , but gasoline prices on the Mainland have only increased by about 30%. Until now, refined oil products in mainland China are sold at the government's controlled prices, which are some 20% to 40% below world market prices even after the latest adjustment.

Thus refineries in the Mainland operating with imported oil are running at a loss and are receiving government subsidies for compensation . Price control therefore not only distorts supply and demand but also constitutes a substantial financial burden for the government. According to the World Bank, such subsidies could reach RMB218 billion or about 0.8% of GDP in 2008 . The latest price hike will help correct part of these distortions and alleviate the financial burden of the government.

To reduce the impact of the oil and power price increase on livelihood, the authorities freeze the price of coal for power generation, and exempt urban and rural residents and the farming and fertilizer industry from the increased electricity charges.

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