How remittances promote consumption stability

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.

This article is published in collaboration with The World Bank’S People Move Blog. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Dilip Ratha is Manager, Migration and Remittances Unit and CEO, Global Knowledge Partnership on Migration and Development (KNOMAD) in the Development Prospects Group of the World Bank.

Image: An employee counts Indian rupee currency notes inside a private money exchange office in New Delhi July 5, 2013. REUTERS/Adnan Abidi.