Can remittances help stablilise consumption?

Remittance inflows to developing countries constitute a resilient source of foreign finance. They contribute to consumption stability and can act as a counter-balance when capital flows weaken. 

Remittances have numerous benefits for development. They have been associated with accelerated poverty alleviation, improved access to education and health services, and greater financial development. In addition, remittances may enable consumers to maintain their consumption levels despite illness or some other calamity, which may be critical at very low levels of income.

Remittances to developing countries are significant 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 largest source of foreign exchange.

The importance of remittances as a source of external finance is expected to grow further as growth in private capital flows to developing countries might well moderate when interest rates begin rising in advanced economies, or if growth in developing economies remains weak.

Remittances as a (more) stable source of income

Remittance flows are relatively stable and do not co-move with economic downturns. Therefore, they can play a stabilizing role during recessions and crises in most receiving economies. In almost four-fifths of developing countries, remittances receipts are not significantly related to the business cycle whereas debt flows and foreign direct investment tend to be procyclical (i.e. rising in good times and declining in times of weak growth).

Remittances have been significantly more stable than other capital flows in the large and growing number of developing countries that receive both. For example, during episodes of “sudden stops” in capital flows, when capital flows fell on average by 25 percent, remittances increased by 7 percent.

This stability of remittances was even stronger in countries with geographically more dispersed migrant population abroad. Those countries tended to receive relatively more stable remittance flows during sudden stops than those with more concentrated migrant stocks abroad. For example, following the sudden stops corresponding with the 2008 financial crisis, remittances continued to increase at a faster pace in countries with more dispersed migrant stocks (See figure).

Remittances, thus, help counter-balance fluctuations caused by the weakening of capital inflows to developing countries. More specifically, remittances help stabilize consumption by making it less sensitive to output movements. Such consumption behavior often enhances welfare.

Through which channels can remittances help stabilize consumption fluctuations?

Remittances, help buffer consumption from short-run gyrations in domestic activity in two ways.

• First, remittances can help stabilize consumption across time by supporting saving. Microeconomic evidence documents that remittances are an important resource to enable households to smooth consumption over time as they help improve access to financial services and ease liquidity constraints.
• Second, even if overall remittances do not increase substantially during economic downturns, a greater proportion of remittance receipts is likely to be used for consumption purposes during such periods. Given that remittances, unlike capital flows, are transfers that do not have to be paid back and target the portion of consumers that are more likely to be liquidity-constrained, they may have substantial effects on consumption stability.

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 (the average cost of sending $200 was about 7.9 percent of the transaction in late 2014), 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.
This post is based on an essay, titled ‘Can Remittances Help Promote Consumption Stability?’, which was published in the January 2015 edition of Global Economic Prospects.

Figure 1 – Remittances and Migrant Dispersion
 (Index numbers)

Source: World Bank staff calculations.
Notes: Zero (0) refers to the year of the sudden stop episode. More dispersed (Less dispersed) refers to countries with migrant concentrations below (above) the sample median. Migrant concentration is defined as the percentage of migrants in the top destination to the total migrant population.

This article first appeared on The World Bank’s Prospect for Development Blog. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Ergys Islamaj is an Assistant Professor of Economics at Vassar College. Seyed Reza Yousefi is Economist of Development Prospects Group (DECPG) at the World Bank. Supriyo De is on leave from the Ministry of Finance, India for a research assignment with the World Bank.

Image: A man walks past buildings at the central business district of Singapore. REUTERS/Nicky Loh.