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China has been promoting the internationalisation of the RMB for two decades. As a result, its offshore foreign exchange market has been substantially revitalised, despite that China’s capital market remains partially open. The movements of offshore exchange rates can provide crucial clues to understanding the offshore market structure and the effects of interventions by Chinese monetary authorities. Using the GARCH-MIDAS model, this paper examines how the degree of openness and economic fundamentals – both observed and unobserved – affect the long-term volatility of offshore exchange rates. We find that, first, trade openness attenuates the long-term volatility, while financial openness has no effect. Specifically, the use of bilateral currency swap agreements and the relaxation of capital control are associated with lower volatility, while stock market connect programs tend to increase the volatility. Second, observed fundamentals, including relative measures for growth, interest rate, and money supply, have significant negative effects on offshore volatility. Third, although economic policy uncertainty and market risk affect long-term volatility, liquidity does not appear to be a culprit of volatility. In terms of FX interventions, direct intervention decreases the volatility, while oral intervention increases volatility.

What determines the long-term volatility of the offshore RMB exchange rate?