Can Remittances Help Promote Consumption Stability?

(Prepared by Supriyo De, Ergys Islamaj, Ayhan Kose, Dilip Ratha, and Seyed Reza Yousefi)
 
Our essay on remittances in the latest Global Economic Prospects (released yesterday) examines cyclical characteristics of remittances and explores the counterbalancing and consumption-smoothing potential of remittances. Remittances to developing countries are significant both as a share of GDP and compared to foreign direct investment (FDI) and official development assistance. Since 2000, total remittances have averaged about 60 percent of the size of total FDI. For a large number of developing countries remittances constitute the single largest source of foreign exchange.

The relative importance of remittances as a source of external finance is expected to increase further if capital inflows to developing countries slow down as interest rates in advanced economies normalize, or if growth in developing economies remains weak. Remittances are associated with significant development impacts such as accelerated poverty alleviation, improved access to education and health services, and enhanced financial development, as well as multiplier effects through higher household expenditures. In sum, the contribution of the study is three folds:

• Remittances are relatively stable and a-cyclical, and therefore, can play a stabilizing role during economic fluctuations in most receiving countries. In almost four-fifths of our sample countries, remittances receipts are not significantly related to the business cycle compared with the pro-cyclical debt flows and foreign direct investment.
   
• Remittances have been stable during episodes of financial volatility when capital flows fell sharply. It is therefore argued that remittances help counter-balance fluctuations caused by the weakening of capital inflows to developing countries. For example, while capital inflows to emerging markets on average declined about 25 percent during the initial year of a sudden stop episode, remittances increased by 7 percent during the same year. The contrast was even more evident during the crisis of 2008 when remittances increased over 10 percent even as capital inflows fell by over 80 percent (Figure 1 and Figure 2). The analysis suggests that the stabilizing effects are greater for remittance-receiving countries with a more dispersed migrant population. 

Figure 1: Remittances and Capital Inflows During 2008 crisis




Figure 2: Remittances and Capital Inflows During Sudden Stops

• Remittances, like capital flows can help buffer consumption from short-run fluctuations in income. To estimate the quantitative effect, the essay considers the impact of remittances on the comovement between domestic consumption and output. The lower is this comovement, the more stable is the country’s consumption. Remittance inflows help de-link domestic consumption from domestic output fluctuations, hence increasing welfare.

The stabilizing force of remittances provides a rationale for removing impediments to remittance flows. Specific actions to be considered include cutting the cost of remittances, such as by encouraging competition in money transfer services; removing remittance taxes; and avoiding multiple currency regimes that reduce the local currency value of remittances.