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SHIJIAZHUANG, China, Sept 16 (Reuters) - The number of Chinese infants found threatened by toxic milk powder is likely to rise as the search for victims spreads, state media reported on Tuesday, with the government facing rising public anger.

Over 1,200 infants have been diagnosed with kidney illness after drinking adulterated powdered milk made by the Sanlu Group.

Two have died and more than 50 are in a serious condition from kidney stones caused by a banned chemical, melamine, added to milk before processing in an apparent bid to fool inspectors.

"Their number could rise as the search for more infants fed Sanlu milk food spreads across the country's rural areas," the China Daily reported. "...The number could rise sharply in coming days as more parents take their children for medical check-ups," the report added, citing Health Minister Chen Zhu.

Melamine is rich in nitrogen, an element often used to measure protein, and can be used to disguise diluted milk.

Twelve months ago, Sanlu was lauded by Chinese state television as a model of reliable quality. But now it and the government's efforts to ensure product safety face searing public anger and questions about the effectiveness of reforms.

Sanlu, 43 percent owned by New Zealand dairy giant Fonterra, last week halted production after investigators announced they had found the problem.

Local Chinese officials acted last week only after the New Zealand government contacted Beijing, New Zealand Prime Minister Helen Clark said on Monday.

"China's dairy industry has grown too quickly for safety administration to keep up. There are no uniform standards and there are loopholes in legal oversight," Lao Bing, manager of the Shanghai-based Mingtai Dairy Industry Sales Fund, told Reuters.

Government inspectors could not deal with the many scattered milk suppliers, he said.

MELAMINE WIDELY USED

Another dairy industry expert, Li Zhiqi, told the China Reform Daily that melamine was widely used. "At every step, people can add melamine to boost the quality of milk," Li said.

China is the world's second-biggest market for baby milk powder, and Sanlu has been the top-selling company in the sector for 15 years, with 18.3 percent of sales in 2007.

Sanlu dominates in poorer rural areas, where farmer and migrant workers often find milk powder is easier than breast-feeding, and sometimes believe it is also healthier.

The government has called the poisonings a "Level 1" food safety incident and formed an emergency team to grapple with the fall-out, the Xinhua news agency reported.

The team ordered an immediate inspection of all the country's milk powder producers, the Ministry of Health said on its website (www.moh.gov.cn). All listed dairy stocks fell their 10 percent limit in early trade but recovered some of their losses later in the morning.

But public anger has grown over claims the company and officials failed to act sooner.

The China Reform Daily cited claims that Sanlu knew about rising cases of infant kidney stones by mid-June, but hoped the problem could be defused without public announcements or massive recalls.

In past years, China has been beset by a series of domestic and international scandals about toxic and unsafe products. In 2004, at least 13 babies died in the eastern province of Anhui after drinking fake powder that had no nutrition.

But last year, Sanlu was lauded by a Chinese state television programme, "Weekly Consumer Report", as a model of good quality.

In past days, Chinese Internet sites have filled with bitter criticisms claiming the broadcaster was more interested in boosting companies than protecting consumers.

"Weekly Consumer Report changes from an attacker of fake and sub-standard products into their protector," said one. (Writing and additional reporting by Chris Buckley; Editing by Nick Macfie and Valerie Lee

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