Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

One group of investors is smiling at the yuan's slump.

Buyers of foreign-currency Chinese debt are benefiting as the nation's depositors pile into dollars. That cash is making its way into the offshore bonds of mainland companies and helping them to outperform.

The People's Bank of China set the yuan fixing on Friday at 6.9168 per dollar, the weakest since 2008. The currency is down 0.4 percent this week alone. Meanwhile, the average spread on dollar bonds from the nation has narrowed more than 3 basis points, as measured by a Bank of America Merrill Lynch index. Chinese bonds are also outperforming other emerging markets.

Home Support
The weaker yuan is helping offshore bonds from China outperform those from other emerging markets
Source: Bloomberg

China's banks are allowed to take foreign-currency deposits onshore and the total amount of those increased by more than 25 percent this year through the end of October. Flush with cash, the lenders are allowed to invest in dollar-denominated assets and they tend to favor bonds sold by companies they know. 

Dollar Calling
Since the yuan's decline accelerated, foreign currency deposits in China have skyrocketed
Source: Bloomberg

Hence, the yuan's decline has accelerated the growth of what is effectively captive demand for Chinese dollar bonds. That helps explain not only the fact that the country's debt is outperforming amid negative headlines over the economy's performance, but also a rash of issuance: China accounts for half the total dollar notes sold by companies in emerging markets over the past two years.

From Light to Heavyweight
China accounted for half of all dollar bonds sold by emerging markets in the past two years, up from 5 percent in 2009
Source: Bloomberg

It's a counter-intuitive result. The law of supply and demand suggests that it should get more expensive for Chinese companies to sell dollar debentures as issuance increases.

Risk is also climbing: The yuan's decline means it's becoming costlier for Chinese companies to service overseas debt, while markets globally have been rattled this year by the Brexit vote and Donald Trump's election as U.S. president. Other things being equal, this additional risk should be reflected in wider spreads.

These factors are being outweighed by the average Mr. and Mrs. Li putting more of their savings into greenbacks. For now. Eventually, the process will exhaust itself: The yuan will find equilibrium and the demand for offshore Chinese dollar bonds will taper off.

At that point, Chinese companies are likely to find themselves having to make dollar coupon payments with an even more depreciated currency -- and buyers of their bonds may discover they have simply exchanged one type of risk for another.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net