SHIJIAZHUANG, China (Reuters) - Hundreds of fraught parents queued on Tuesday outside a Chinese company at the centre of a baby milk scandal, demanding explanations and compensation after over 1,200 infants fell ill and at least two died.

Local residents stand in lines at the headquarters of the Sanlu Group to receive a refund on their milk powder products in the city of Shijiazhuang, located around 300 kilometres southwest of Beijing, September 16, 2008. (REUTERS/David Gray)

In past years, China has been beset by scandals about toxic and unsafe products. In 2004, at least 13 babies died after drinking fake powder that had no nutritional value.

Now hundreds have been diagnosed with kidney stones after drinking powdered milk made by the Sanlu Group and adulterated with toxic melamine. Two have died and more than 50 are in a serious condition.

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

Businessman Yang Letong, 34, said his toddler twin daughters had drunk Sunlu products since they were born.

"So what if they give us our money back, you can't give our children their health back," he said outside the company's headquarters in Shijiazhuang, capital of Hebei province, south of Beijing.

"I am angry," he said, tears welling in his eyes. "I'm furious."

Hebei police arrested two dealers on Tuesday for selling adulterated milk to Sanlu, bringing to four the total so far arrested, state news agency Xinhua reported. One of the newly arrested men ran a farm that produced 3 tonnes of milk a day.

Police have detained another 22 people for questioning about the illicit business, added Xinhua.

China's Health Ministry has pledged free health care for babies sickened by the contaminated milk powder but also warned the numbers of those affected could rise sharply, Xinhua said.

"... the number of parents who take their children for medical check-ups could rise drastically in the future," said Deputy Health Minister Ma Xiaowei, according to Xinhua.

"WE THOUGHT IT WAS SAFE"

Many of those demanding an explanation sat on boxes of Sanlu milk powder that they had brought back for a refund.

"We thought it was safe," said housewife Wang Qin, 30. "Nobody knew this could happen. My 11-year-old son grew up with their products." Throwing a box of yoghurt on the ground, she added: "I'll never touch their stuff again."

Melamine is rich in nitrogen, an element often used to measure protein, and can be used to disguise diluted milk. It is the same additive which caused the deaths of pets in the United States last year from contaminated pet food.

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.

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.

The government has ordered an immediate inspection of all the country's milk powder producers. All listed dairy stocks fell their 10 percent limit in early trade but recovered some of their losses later in the day.

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

Signs pronouncing "quality is life" and "pay great attention to product safety" are prominent around the company compound where one official, overseeing compensation work, tried to downplay the scandal.

"Only a few children have become sick," he told Reuters. "Most of them are fine."