I hear a lot about offshore and onshore currency, but I don't understand the difference between them. What is the difference between onshore and offshore currency in a country? Besides that, why is there a need for having two different currencies in the country??
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3 Answers
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Certain regulations in a country might inhibit the values of a unit of currency from being the same within the borders of the country and outside. There might be foreign exchange or banking regulations.
For example, the eurodollar rate is different from the dollar inside the US, since there are reserve requirements dictated by the Fed.
Basically, same underlying currency just different regulatory regimes give rise to different values.
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2$\begingroup$ The broad study area of the difference between onshore and offshore assets prices is called convertibility risk. This is very relevant for alternative investments such as emerging markets. investopedia.com/terms/c/convertibility.asp $\endgroup$ Commented Jul 6, 2016 at 12:54
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It's because of onshore capital controls; units of currency cannot freely enter and leave the country and so currency held onshore (within the domain of the capital controls) is not fungible with currency held elsewhere. Hence, due to the limitations of arbitrage, those two currencies are not tightly coupled. They are related, since actual physical onshore exporters may be allowed to accept offshore currency (or vice versa for importers), but not perfectly.
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I know it's an old question, but having worked for 20+ years with Latam markets, I may be able to help with this.
First, an example: for the Brazilian Real, you have the onshore and offshore market because the Brazilian Real (BRL) is not freely convertible and has tax implications.
You also have the convertibility risk. One day, the government may decide you can't sell your BRL for USD in Brazil, as with the "corralito" that happened in Argentina about 15 years ago.
Therefore, some players may want to trade BRL offshore to avoid tax, regulation, and potential cross-border risk. Consequently, the offshore market tends to be lower (less risky) than the local/onshore market.
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2$\begingroup$ There are two related cross-border risks: "convertibility" - a government restricts conversion of its currency, onshore BRL has this risk, "global BRL bonds" and non-delivery forwards don't; and "transferability" - a government restricts repatriating assets, no matter what currency. "USD in Brazil" or "USD in Argentina" subject to local jurisdiction pay a little higher yields than global USD to compensate for the transferability risk. $\endgroup$ Commented Nov 14 at 16:29