Why the G20 could be the making of China

Forget Janet Yellen and Mario Draghi – the man to watch next year is Xi Jinping. Touted as the most powerful Chinese leader since Mao Zedong, Xi may have rattled the world's markets this year, but 2016 will be all about making it up to them.

Fortunately for Xi – and the world – China has taken over the presidency of the G-20 group of industrialized nations. The relevance of the G-20, whose goal it is to foster sustainable growth and economic stability, has been falling since the end of the financial crisis. But if there is one country whose voice on growth would be taken seriously, it's certainly China.

Chinese President, Xi Jinping
Lintao Zhang | Getty Images News | Getty Images
Chinese President, Xi Jinping

Xi has already demonstrated that he is as comfortable dining with the Queen, as he is visiting the White House or mingling with CEOs. He has selected his theme for the G20 presidency of "building an innovative, invigorated, interconnected and inclusive world economy" -- a clear sign that he wants to make the gathering of political leaders relevant again.

The recent slowdown in growth rates of the world's second-largest economy has been a concern for all. With the US in election limbo for most of 2016, what China does next year will affect everyone.

Being a responsible member of the international global community means China will have to continue down the path of reforms. This month's announcement from the International Monetary Fund that the yuan will be included in the basket of reserve currencies highlights how important this reform agenda is. The IMF inclusion may be as important for China as the entry into the World Trade Organisation in 2001, which had a profound impact on the country's manufacturing sector. Similarly, the yuan's new status may reshape China's role in the financial economy. It is also the most recent proof of Xi's determination.

Should that resolve and commitment to reforms come in doubt, the presidency of the G20 should serve as a straitjacket for China. Against a backdrop of market gyrations, rising corporate debt defaults and a probe into the financial industry, arguably a straitjacket is exactly what's needed.

More than ever, China will be walking a political tightrope over the next year: It needs to balance up its decisions from a global perspective while resolving its domestic issues.

At home, Xi is confronted with the mammoth task of rebalancing the economy away from its dependency on exports to a greater focus on domestic demand, consumption and services. That rebalancing has slowly but surely begun to bear fruit: Domestic demand, consumption and services now represent over 50 percent of China's economy while four years ago the achievement of this policy goal was widely doubted.

Xi has already laid out bold plans to reform state-owned enterprises, strengthen environmental controls and fight corruption. Most of the Chinese companies we invest in are optimistic for the future because the playing field is being tilted more toward the private sector. The government is not restricting the proliferation of goods and services and is actually encouraging the use of technology as a means to raise living standards.

China's consumer services sector last year created about 13 million new jobs and added another 7 million jobs in the first half of this year. On the other hand, China is making the necessary adjustments to address overcapacity and imbalances in other industries, such as steel production, even if that leads to job losses.

Luckily, the international and domestic agendas appear to be aligned because a stronger China will mean stronger global growth.

The government still needs to find an exit strategy for its holdings of stocks from the ill-conceived effort to stabilise the markets in the third quarter and continue to open up capital markets for foreign investors. If they manage to do this, Chinese equities could be included in global stock market indexes. This would be a game-changer for the Chinese capital markets and for investors globally.

China is in the spotlight for the next year and Xi will have to not only talk the talk, but walk the walk. And I'm sure he will. After all, he wouldn't want to lose face when the whole world is watching.

Commentary by Michael Lai, investment director at GAM