Remittances have been in existence for a very long time. Although in these current years, remittances have become an enormous phenomenon in international financial transfer. Remittances are becoming a key source of funding for many projects in developing countries. Surveys show that remittances are the second largest financial in flow that developing countries receive. [1]
Remittances have been described in various ways like monetary payments transferred between people or organisations. [2] It has also been described as transfer of money from family members to recipients in other countries. Wikipedia sources also describe remittances as the accounting concept of monetary payment transferred by a customer to a business. [3] So, there can be various views and ideas of describing remittances.
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There also 2 major ways of classifying remittances: domestic remittances which is when funds are transfers from one location to another within the same country. In most cases, it is transfer of funds from an individual in a city to a recipient in the rural area or village. Meanwhile, the other type of remittance, international remittance is transfer of funds from country to country. More like, from an individual from a developed country to an individual in a developing country.
However, I would like to describe remittances in my own words as, money sent by individuals who work and live in developed countries to family members or recipients who live in their home countries or country of birth. And for the purpose of this essay, all remittances would be referring to international remittances.
There are various forms of international financial transfer. Examples are; Financial Aids- monetary help from developed countries to developing countries; Foreign direct investments( FDI)- investment that earns interest in ventures that function outside its country of origin ; Loans from organisations like the World Bank, EU etc; Foreign portfolio- which includes equity investment.
This essay would be looking at the concepts of remittances, core advantages as well as disadvantages of remittances in developing countries and it would also be relating theses advantages and disadvantages with other forms of international financial transfers (IFT): which have been outlined above. I would also be giving reasonable amount of facts and figures I have gotten from my research that would show the impact that remittances have had and is having on developing economies.
New data shows that in 2008, the amount of remittance that went to developing countries reached $328 billion. [4] It is said by the World Bank that, remittances count as one third (1/3) of total global external finance. 1/6 of the planets population are receiving some form of benefits from remittance flows. For some countries, remittances sum up to more than 35% of their total GDP. World Bank researchers have given figures that, remittances in Tajikistan sum up to 45%, Moldova 38%, Lesotho 29%, Tonga 35%, Honduras 25%, to mention a few. [5]
In 2006, 150 million migrants worldwide sent more than $300 billion to their families in developing countries. Among the ten largest recipients of remittances based on 2008 research findings are: India, which topped the list by sending about $45 billion, followed by China with $35 billion, Mexico with $32 billion. Others include the Philippines, Poland, Nigeria, Romania, Egypt, Bangladesh and Pakistan. [6]
Figure 1(data in $billion): Source- Watson, Roderick (2007) “The Unrest and Movement of the Century”: The universe of Wrecker. The journal of Stevenson Studies 4 and World Bank, “Payment and Remittances”
Looking at the pros and cons of remittances, I would say there seems to be more pros than cons of the effects of remittances. The positives of remittances have outweighed the negative effects of remittances on developing economies.
Remittances help to increase the standard of living of the families that receive them. This positively affects them by increasing their day to day available spending money. It can also help increase consumption of these families as a kind of financial injection as a result, increasing national income and affecting GDP. It facilitates human capital investments particularly in increasing education of children. It can also help provide food, clothing and health care. [7] Unlike other forms of IFT, remittances benefit targeted families and individuals. It has a direct effect on the recipients. Although, on the other hand, it may finance for unproductive spending. The recipients usually use funds received for the consumption of the basic needs, buying medicines, foods, and clothing. But, if there’s always inflow of remittances, funds may be used unproductively for unnecessary items.
Also, it reduces poverty and income inequalities by raising the average level of income per capita and helping to equalize the income distribution. Unlike other forms of IFT, it doesn’t directly affect the individual who might necessarily need them, but the trickle down effect, makes it possible for the entire community to benefit jointly from sources like Aids and government infrastructures. Looking at this as a con, this can also create a barrier between the haves and have not’s. This creates an obvious disparity between the ones who receive remittances and those who don’t.
Remittances help to increase the rate savings and as a result increase investments. This is an individual demeanour depending on the region and economic conditions of the recipient of remittances. Researches proof that mothers that receive remittances use these funds to facilitate their homes more than for personal and irrelevant spending. Contrarily, it can promote idleness among recipients. As the basic needs are met by the remittance funds, recipients tend to stop working. This has a direct negative effect in labour supply and economic output.
Remittances flows have a constructive impact on financial developments consisting of increasing the access and use of financial intermediaries likes banks especially in the rural areas. Many remittance receivers tend to own bank account, and this helps to improve the existence of financial intermediaries.
Remittances help improve credit ratings of countries and help raise external financing. Inflows would efficiently reduce the country’s debts reasonably to its income and improve the country’s creditability thereby reducing its cost of borrowing/ interest rate in the international capital market. [8]
It can also help developing countries raise external financing through securitization. Here, banks that receive remittance in developing countries, can issue bonds to foreign investors with the backing of future flows of remittances. [9]
Remittances are not as high as other flows but they are certainly less unpredictable. Below is a chart showing the steady increase of remittances from 1975 to 2004 unlike Financial Aids and FDIs.
Figure 2: IMF, BOP year book (2006), IMF Department database (2006) and OECD development Assistance Committee Database (2006)
Harmfully, remittances can lead to currency appreciation causing exports prices to go up and import prices to be cheaper. As a result, there is a reduction in export levels, and increase in import levels. This can also affect the production markets by reducing the availability of jobs. [10] Creating a malfunction in both the currency and labour market. Also, it can lead to the Dutch disease: when there is an increase in the amount of foreign currency in the country because domestic currency has become expensive compared to foreign currency.
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A significantly important disadvantage is, it can also encourage more migration of labour because family members receiving remittance think that they would be better off moving to developed countries and earn more money rather than staying in their home county. This on the long run can cause a negative impact, often referred to as “brain drain” whereby the population is filled with uneducated individuals or people outside the labour market range. [11]
Although, unlike Aids and remittances and other IFT, FDIs can be more advantageous to the economy of developing countries because there are more jobs available to the nationals, there would increase in government incomes when taxes are paid by these firms. However, FDIs can also be disadvantageous because workers in developing countries can be exploited and over used and paid very little wages.
Another con of remittances is that it increases the country’s dependence on remittance rather than investments. However, a sudden stop in the in flow of these remittances can cause serious financial crisis. And if the country’s pillars are backed majorly by remittances, the crisis would be even worse.
Since the 9/11 crisis, America’s incentive to combat terrorisms has seen to the implementation of the financial action taskforce. This body was set up to look into informal methods of remittance method: which may have helped to fuel the terrorism activity in 2001. This taskforce work to curb money laundering and terrorism financing. In order to help improve the transparency of remittances, the WB have also recommended a number of systematic implementation which remittance senders and receivers must abide to in order to send or receive money formally. [12]
In conclusion, remittances to developing countries have potentially far reaching effects. There are both positives and negatives to the encouragement of remittances; however, evidences suggest that, overall the effects of remittances compared to other forms of international financial transfers has a positive direct effect on recipients and should be encouraged with suitably persuasive policies from the relevant governments.
Further researches by the World Bank claim that in from this year, remittances in developing countries would fall less than expected. Although remittances, among other forms of international financial transfer, have been the most stable, there is the likeliness that this pattern is about to change. The reason is not plainly stated but suggestions are: the effect of the current economic crisis; cost of sending and implementation of stricter sending principles [13] . Nevertheless, with a drop in the percentage of remittances, it would still be the highest flow of international financial
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