FORTUNE — In the year since China’s new leadership assumed power, it has made repeated pledges to restart the nation’s movement toward economic reform. China’s new premier, Li Keqiang, even used a rather bloody Chinese metaphor (“a hero is not afraid to cut off his poisoned arm”) to show his resolve.
Regrettably, the last 12 months have seen only cosmetic changes to China’s economy. A minor lending rate was freed and a pilot free trade zone in Shanghai was approved (although how free it is remains to be seen). In the meantime, credit-fueled, investment-driven growth has continued unabated, worsening macroeconomic distortions and creating even greater risks in the financial sector.
China’s new leaders will have a historic opportunity next month to convince the Chinese public and the international community that, in spite of a disappointing first year, they are prepared to tackle the most difficult reforms. The Chinese Communist Party (CCP) will convene the third plenum of its central committee, most likely in the first half of November. Many hope that the party’s leadership will unveil an ambitious and comprehensive reform agenda at the gathering.
While it is understandable that investors around the world are rooting for political resolve and policy clarity from Beijing, we should also be realistic about what Chinese leaders can actually deliver at next month’s meeting. Most critically needed reforms will likely face strong opposition from entrenched interest groups (state-owned enterprises, local governments, the bureaucracy, and businesses connected with the ruling elites). For example, liberalizing interest rates will raise the cost of capital for state-owned enterprises. Cracking down on shadow banking will push many overleveraged real estate developers into bankruptcy. Bold policy moves, such as reducing the issuance of bank credit to rein in unproductive investments and cutting excess capacity in many manufacturing industries, will likely lead to deflation and a sharp fall of growth.
In this context, we can only expect more measured and prudent initiatives coming out of the party plenum. In all likelihood, we will hear encouraging reform proposals stated in general terms. For instance, the party’s leadership will probably endorse principles of fiscal reform, financial liberalization, environmentally friendly growth strategy, innovation, and social equity. On the fiscal front, proposed restructuring of the current (dysfunctional) fiscal system might include broadening the tax base of local governments (which rely excessively on revenues from land sales), tweaking the formula that allocates revenues between provincial governments and the central government, and shifting the costs of some social services to the central government.
When the party attempted similarly ambitious reforms two decades ago, it took a full year for the central government to negotiate with various stakeholders and come up with specific policies. So, it is unlikely that the policy pronouncements delivered at the plenum will include many specifics. To be sure, the leadership’s reform rhetoric will be strong. But its political commitment to reform will remain difficult to gauge.
Unfortunately, Beijing does not seem to have a credible political strategy to go alongside its economic reform. The conventional wisdom today is that Xi Jinping, the new Communist Party chief, is using a high-profile anti-corruption campaign to scare the bureaucracy, creating more favorable conditions for economic reform.
What most people forget is that Xi will have to rely on the bureaucracy to carry out a campaign against itself. This top-down approach is likely to lose its potency because Chinese officials are skilled political operatives who know how to deflect and dilute central government policies. They have formed tightly knit, collusive networks to protect each other. They often feign compliance while carrying on business as usual.
It would be more realistic for Xi to rally public opinion and the Chinese people behind a pro-market reform strategy (which, incidentally, Deng Xiaoping did in the late 1970s and early 1990s). But political conservatism emanating from Beijing precludes this option.
For the Chinese public and foreign investors, the third plenum will unlikely lift the fog of policy uncertainty. It may send us more signals on how Chinese leaders would like to reorient China’s growth strategy, but the devil, as we all know, is in the implementation. And we will have to wait at least one more year to see if any of the policies announced at the plenum can be put into action.
On the other hand, China’s annual national economic work conference, which is scheduled for the second half of November, might yield some results. Unlike the plenum, which is devoted to the big picture, the national economic work conference focuses on short-term, high priorities. One of those priorities is financial deleveraging. In the last five years, China’s outstanding credit has grown from 130% to 220% of GDP since 2008, an unprecedented increase for the nation. With high-risk borrowers like corporations and local governments accounting for debt totaling 195% of GDP, an unknown, but significant, portion of the assets in the banking sector is not earning anything. It’s dead money.
How Beijing handles this daunting problem in late November will do a great deal to calm or further scare the market. If China’s leaders adopt a transparent plan backed by real money to defuse this ticking debt bomb, confidence will return. If Beijing attempts to use dubious accounting schemes to sweep the bad loans under the carpet (the plan being talked about is to set up provincial asset-management companies, or bad banks, to take over the dud loans, with no provision as to how such bad banks will be financed), deep skepticism about China’s economic future will continue to dog Beijing.
Minxin Pei is the Tom and Margot Pritzker ’72 Professor of Government at Claremont McKenna College and a non-resident senior fellow at the German Marshall Fund of the United States