Interest Arbitrage under Capital Controls: Evidence from Reported Entrepôt Trades

Capital controls segment the offshore credit market of Chinese renminbi from the onshore one. Using a novel administrative data set, we provide evidence that firms arbitrage the onshore-offshore interest differentials using... [ view full abstract ]

Capital controls segment the offshore credit market of Chinese renminbi from the onshore one. Using a novel administrative data set, we provide evidence that firms arbitrage the onshore-offshore interest differentials using bank-intermediated "entrepôt trades," which supposedly re-export imports with little or no processing. Onshore-offshore interest differentials drive renminbi's inflows from "entrepôt trades," which strongly predict one-year forward outflows settling bank-issued Letters of Credit. Interest differentials have greater impacts on the lower half of the outflows distribution and induce entries to "entrepôt trades." Our findings suggest that renminbi interest arbitrages are feasible but costly under capital control.