Liquidity matters: offshore RMB’s CIP deviations with major currencies

Persistent deviations from covered interest parity exist in the offshore RMB market, yet the underlying transmission channels remain unclear. This paper conducts an empirical investigation using monthly panel data on the RMB against four major currencies. The findings reveal that improvements in offshore RMB liquidity significantly reduce CIP deviations, and capital control intensity moderates this relationship. The core mechanism operates through transaction costs as a key market friction: in a high transaction-cost environment, liquidity tightening amplifies CIP deviations more strongly. These findings advance literature from identifying isolated drivers to understanding the interaction between market frictions and macroeconomic conditions.