In a major economic reform, China is planning to let market forces play a dominant role in the production of more than half of the nation's industrial goods, according to official news reports today.

The reform will free all but the key industrial and farm goods from rigid state production quotas that form the basis of a planned Marxist economy.

It is seen as a dramatic injection of capitalist tonic to enliven output and to give China's centralized distribution system more flexibility.

Factories and farms now gear their output to annual targets set by the Communist government, churning out products without clear market signals. As a result, many goods are in short supply while many others rot in huge stockpiles.

The new policy devised by the State Planning Commission will allow certain enterprises to target production according to market demand or general guidelines recommended by the state.

A front-page story in China Daily, the country's only English-language newspaper, said the reform will begin next year and will cover 60 of the 120 industrial goods and 19 of the 29 agricultural products for which the state assigns annual production quota targets.

While these enterprises produce more than half of the items included in the state plan, they apparently represent a small share of the total value of production.

Major economic sectors are to remain under tight state controls, including coal, oil, rolled steel, large machinery, synthetic fibers, timber, cigarettes, chemicals, nonferrous metals, munitions, electrical equipment, cotton, cooking oil, cereals, jute and pigs.

China Daily failed to specify those products covered by the reform, but they apparently include textiles, light consumer goods, fruit, vegetables and most livestock and aquatic products.

The reform assigns a large degree of autonomy to industrial managers and farmers who will be expected to size up market demand, plan output every year and find wholesale customers.

It is unclear, however, how prices will be set.

Western diplomats believe the measure unveiled today is the harbinger of long-overdue price reforms that would help define market demand.

Almost all Chinese products are priced by state planners according to their concept of public need, not actual demand.

About 25 percent of government spending in China now goes for price subsidies on basic items such as food, housing and transport, and Premier Zhao Ziyang has warned that the government cannot allow this to go on indefinitely.

Prices of many goods are kept artifically low, subsidized by the state to make them affordable.

As a result, a bag of coal costs the same as a a bag of sand.

The subsidy system not only depletes state coffers -- it accounts for half of the national budget every year -- but it also sends incorrect signals to manufacturers.

One out of every five Chinese factories lost money last year because of poor planning, running up total losses of more than $1 billion.

More than $60 billion worth of electronic and machine-building equipment and 20 million tons of steel lie rusting in state warehouses because of lack of demand.

At the same time, consumers fight over the relatively few refrigerators and bicycles produced every year.

Advocates of price reform argue that prices should be allowed to float to the level consumers are willing to pay, thus giving manufacturers an accurate reading of demand as well as the funds to invest.

Peking has postponed price reform for years for fear of political fallout caused by sudden spurts in the price of staples.

But diplomats said the decision to free large numbers of goods from the state plan indicates that Peking is preparing for fundamental restructuring of its pricing system -- perhaps as early as later this month, when the Communist Party Central Committee is scheduled to meet. The party has not announced an exact date for the meeting, but some diplomats said they expect it may start next Monday.

Although key industrial goods will remain under state controls, new measures revealed today will attempt to increase the efficiency of factories producing them.

According to China Daily, factories will be fined for falling short of annual targets.

As an incentive, however, the factories will be allowed to sell any surplus at "flexible prices."

This appears to extend to the industrial sector the successful reforms that have boosted agricultural output.

Farmers are permitted to sell at free markets whatever they grow above state quotas.