This paper studies supply- and demand-side drivers of covered interest parity deviations(CIPD) by leveraging novel micro-level transaction data from 2015 to 2024. We construct sector-level measures of excess demand for dollar funding across 12 types of market participants, based on changes in their net short dollar positions, defined as the outstanding far-leg dollar obligations vis-à-vis local banks. Applying a granular instrumental variables method to this uniquely constructed dataset, we decompose CIPD into the contributions of domestic and foreign participant groups, providing a detailed view of the underlying forces behind deviations from parity. We find that supply forces of foreign investors’ account for 61% of CIPD throughout the sample period, while the demand forces of domestic agents’ are responsible for the rest.

The paper also examines the impact of CIPD on the spot exchange rate and capital flows. Using the decompositions as instruments in local projections, we show that CIPD increases foreign inflows and reduces domestic outflows. Furthermore, CIPD appreciates the spot exchange rates when instrumented with non-deliverable forward. Our findings highlight the importance of identifying the underlying micro-level forces of CIPD in understanding its macroeconomic implications.