Two important points as a preamble: First, the turmoil in the stock market might well continue but it has almost no bearing on the "real" Chinese economy and the regulators and policymakers in Beijing are fast learning how to manage that. Second, the rebalancing of the economy is beginning to materialise as ground reality: To put it simply, the closer you are today to the traditional industrial sectors, mostly dominated by SOEs, the more you hurt; but the closer you are to new economy activities - where the role of the private sector is more pronounced - the better off you are, with high growth rates and profits. Of course, at this stage the boom and job creation in the new economy is not able to compensate for the negative impact of the deceleration in traditional industrial sectors. Thus China's present economic and business landscape - and hence, also, the arduous, long and painful process ahead.
This leads to the first dilemma the leadership is facing: China needs aggressively to address the over-capacity affecting all the traditional industrial sectors and the ever-rising mountain of corporate debt (now more than 60 per cent higher than in 2008). This would involve closing a number of SOEs which are zombie companies accumulating debt and stockpiles. However, the leadership wants at the same time to avoid massive layoffs of SOE employees who would not only lose their jobs but also the social benefits associated with their employment. Paradoxically, while the government speaks of streamlining the SOE sector, it is also asking these companies to hire the 300,000 soldiers made redundant by the reform of the military set in motion by President Xi Jinping. So, despite the fact that the Central Economic Work Conference held by the leadership last December pledged to tackle the over-capacity issue, we have to expect a pattern of one set of measures going in that direction and other measures contradicting the official goal or complicating its achievement.
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The second dilemma is linked to the first. President Xi and his colleagues know that the much-needed restructuring and re-balancing of the economy towards more knowledge-based, higher-added value activities - and towards increased household consumption instead of over-reliance on investment and exports - absolutely requires a greater role for the private sector and a greater ability to fulfill huge un-met demand from the people. Such a course implies a reduction of the role of SOEs in the overall structure of the economy and creating a more level playing field between the state sector and the private one with respect to the allocation of resources. This also means opening up to the private sector activities which were until now the monopoly of SOEs.
This raises two big issues. First, Mr Xi remains intent in preserving for the SOEs the control of the commanding heights of the Chinese economy; second, even if he is ready to move cautiously in expanding the role of the private sector, he cannot ignore the resistance of the mammoth state-owned conglomerates fighting tooth and nail to preserve huge privileges and power. So, here again expect a pattern of one or two steps forward, one step sideways, one step back.
Comes the third dilemma: On the one hand the leadership now fully recognises the need for action on the supply side involving the lowering of costs for businesses, tax cuts, easier access to credit for private sector companies. Thus additional rate cuts and decreases in the credit-deposit ratio are in the offing. But this will mean a higher fiscal deficit in 2016 - after this deficit had already doubled in 2015 over 2014, at $358 billion. Most developed economies would indeed dream of a fiscal deficit of only 2.7 per cent of GDP. But what is worrisome for the Chinese leaders is the trend at play here - especially when linking the evolution of the fiscal deficit to the country's overall debt, now at 282 per cent of GDP. More importantly, the key question is whether a looser fiscal policy will have the desired impact if the private sector's role is not expanded enough and the inefficiencies in the SOEs are not cut down more significantly.
The fourth dilemma is that the Central Economic Work Conference last December confirmed the orientation towards a more flexible monetary policy, allowing the renminbi to depreciate even more against a basket of reference currencies as the US dollar continues presumably to strengthen. This, however, means an additional weakening of the Chinese currency, which has already lost five per cent of its value against the dollar in 2015. The risk is that this will trigger - as we have seen already - reactions in the international markets that are difficult to control and that would lead to a much sharper depreciation of the renminbi than intended by Beijing. The People's Bank of China has already spent around $400 billion since the summer of 2015 to defend its currency with reserves now standing at $3.3 trillion. So managing a more flexible monetary policy will prove to be a high-wire balancing act this year, testing the ability of the People's Bank not only to manage contradictory pressures but also to communicate in a way that anticipates market reactions.
Pessimists will say that the kind of reform orientations that came out of the Central Economic Work Conference have already been promised before with no significant results. But the pressure has now increased on the leadership. President Xi has been speaking of the need for annual GDP growth of 6.5 per cent in the course of the 13th five-year plan, and he knows that this is not achievable in the present structure of the economy. So it could well be that, as Henry Kissinger once observed, "the absence of alternatives clears the mind marvelously" and that the forthcoming annual meeting of the National People's Congress in March will endorse a set of decisive reforms by approving the new five-year plan running into 2020. But the odds are for a succession of measures trying to accommodate contradictory needs and pressures. This makes for a bumpy, difficult and volatile year for China - but, at the same time, don't listen to the prophets of gloom warning of a hard landing that is not likely to happen.