Beijing needs to match Wen's anti-inflation talk with action

When he stood up on Saturday to deliver his annual work report, Premier Wen Jiabao was clear what his government's main concern should be this year.

Rising prices threaten social stability, he told the party functionaries assembled in the Great Hall of the People. As a result fighting inflation will be Beijing's 'top priority'.

Wen is certainly right that price rises are politically dangerous. A bout of runaway inflation in the late 1980s was one of the key factors that led to the Tiananmen Square protests of 1989. And it was hyper-inflation that finally toppled China's nationalist government in 1949 and brought the Communist Party to power.

So Wen and his colleagues at the top of China's government should be in no doubt about the importance of clamping down on price rises. The trouble is that fighting inflation will be hard, if not impossible, when so many of the government's other policies are helping to fuel higher prices.

According to official figures, China's consumer inflation rate was running at 4.9 per cent in January. That might not sound too bad, but food price inflation is in double digits (see the first chart), and many people complain that the official numbers understate recent increases in the actual cost of living.

Despite the dangers, however, official efforts to combat inflation have looked half-hearted. The central bank has raised interest rates twice in recent months. But key rates remain below the rate of inflation as policymakers have shied away from more aggressive increases.

Instead the central bank has concentrated on managing the amount of liquidity sloshing around the financial system. It has ordered banks to set aside more of their deposits as reserves, and commanded them to cut back on lending.