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Remittances to the Rescue!

Poonam Gupta's picture

These are tough time for many emerging markets and developing countries. The international capital flows cycle seems to have been in reverse gear, throwing many countries off guard. As the global risk appetite has declined, countries have witnessed reversal of capital, hardening of cost of capital, correction in stock markets and depreciation of their currencies. Adjusting to these developments may require a reversal in the current account deficits of some of these countries. To what extent could this correction come through an improvement in remittances?

Let’s take the example of India to look at the role that remittances could play in improving the current account balances in developing countries. India has been the largest recipient of remittances in the world for several years. Due to an ever expanding stock of migrants abroad, remittances to India have been growing at an average rate of 15 percent a year for more than a decade now, and the annual flow of remittances reached almost 65 billion USD in 2012. To put it in context, the amount the country now garners per year through remittances is almost half the revenue from the exports of services.

India has been one of the worst affected countries, caught in the current storm of retrenching liquidity. Already experiencing a structural slowdown in the economy, a worsening current account deficit as well as fiscal deficit since 2011, it is now also experiencing a sudden stop of capital. Consequently the Indian rupee has depreciated by 26 percent between January and August 2013, and by 8.8 percent in August, 2013.

Even though the stock of foreign reserves seems conformable, and indeed above the levels recommended by the IMF in its latest staff report on the Indian economy, the adjustment to these developments inevitably would require some correction in its current account balance. It seems likely that increased remittances flows would contribute to this adjustment.

Existing research shows that since a large proportion of the migrants from India consists of skilled labor, remittances sent home by them are affected less by the adverse business cycle conditions in the countries they migrate to. At the same time remittances are seen to be counter cyclical to economic growth in India. Thus remittances rather increase when growth in India slows down and possibly when the exchange rate is weak.

 
These factors would imply that even as the exports of goods and services grow faster in response to a competitive exchange rate (structural constraints in the economy notwithstanding), remittances may indeed be the first inflows to respond to a slowing economic growth and depreciated currency, and may provide the much needed cushion to the current account.

A report in Financial Times predicts that the remittances may increase by an additional USD 10-15 billion in the current year in response to the depreciated exchange rate. If indeed these were to materialize, the additional remittances would be sufficient to close about 12-15 percent of the projected current account deficit for the current year.

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