Much has been written about the opportunity China has to demonstrate its global leadership credentials in 2016 as G20 chair. It has been described as an historic opportunity for the world’s second largest economy to make its mark.

Now 2016 has begun and China is indeed dominating the economic news, but for the wrong reasons. Many stock markets have had their worst start to a year in decades, primarily due to concerns over China.

What bearing will the jitters over the outlook for the Chinese economy have on its role as G20 chair? It wouldn't be much if there were low expectations to begin with. But there has been considerable anticipation that as G20 chair, China would play a role in global economic affairs that reflects its economic weight. In doing so, it has also been hoped that China would help save the G20; there is, in short, plenty of pressure on China to ‘deliver’ as G20 chair.

As to what it has to deliver, rather than the lengthy action plans and unrealistic targets that have been the hallmark of recent G20 summits, the global community is seeking reassurance policymakers are effectively guiding the future direction of the Chinese economy.

Maintaining balance when assessing the Chinese economy is a challenge. There are many exaggerated claims and predictions. The most recent is the George Soros comment that China’s economic problems could lead to a global crisis similar to that in 2008.

Gyrations in the Shanghai stock market, which has tumbled over the past week (including falls of over 7% in just 30 minutes before trading was suspended), have little direct impact on the Chinese economy. And the fact this economy is slowing is not news. Chinese economic growth has been weakening for years. This is a conscious objective of policy makers as they seek to transition China from a growth model based on massive investment to a more sustainable path centred on consumer expenditure.

What is worrying is that one of the reasons for the current bout of market turbulence is concern over Beijing’s capacity to handle the complex task of managing the transition of a large and complex economy. Eswar Prasaad from Cornell University noted: ‘The ongoing rout in China’s stock and currency markets reflects a sharp erosion of confidence in the economic policy skills of Chinese policymakers’. While the ability of the Chinese authorities to maintain strong growth for over a decade has been admired, more recently there has been poor communication of policy intent, clumsy attempts to manipulate markets, and backsliding on policy reforms.

One area of concern is China’s exchange rate policy. At a time when China is meant to be internationalising its financial system, and the renminbi is to joining the basket of currencies that determine the value of the IMF’s Special Drawing Right, we have the spectre of China initiating a currency war. China shocked markets in August 2015 when it suddenly pushed its currency down by 2%. Beijing said it was responding to market pressures, but there was concern that it was motivated by worries over the growth outlook and the need to boost exports. The renminbi stabilised against the US dollar for a few months, but more recently it has declined by more than 4% and is at its lowest level against the dollar since 2011.

While talk of a currency war continues, a more immediate concern is that China will experience increasing capital flight as investors reassess the outlook for the economy. The Chinese central bank has attempted to moderate the fall in the currency, but its attempts to orchestrate an orderly decline are probably exacerbating the fall and adding to investor concerns.

Mohamed El-Erian has pointed out that on a standalone basis the recent volatility in Chinese markets does not warrant a massive sell-off in global markets, but what also needs to be factored in is the cumulative impact of long-term distortions in China’s financial system. He concludes:

A major adjustment of policies is needed if the distortions are to be resolved in an orderly fashion. Otherwise, market forces could well force a reconciliation that will be a lot more disruptive to the financial system and global economy.

So the chair of the G20 in 2016 may be the economy that poses the most significant risks to the global economy. As such, the pressure will be on China. It may have an ambitious agenda for the G20 in 2016, but success will crucially depend on policymakers demonstrating they can manage the Chinese economy. The authorities have to establish that they are pursuing sound, consistent and measured policies which take into account the impact on other countries, and that will not aggravate global financial instability. As Christine Lagarde has emphasised, this will require greater clarity from China on its economic policies.

As the G20 chair, the pressure is on China to lead by example.

Image courtesy of Flickr user AK Rockefeller