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Impact of home remittances on developing economies

Published on 5th Sep, Edition 36, 2016

 

Developing countries are exposed to globalization owing to the volatility of international markets. The increase in inflows and flight of capital can have significant effects on the economy. In many developing and emerging economies, remittances are financial flows that is as important as, and in some cases more important than, capital flows. It is often observed that remittances are more stable than capital flows to emerging and developing countries but despite this fact, remittances are also subject to shocks.
Developing an understanding about the nature and economic drivers of remittances to Pakistan is crucial to critical thinking about its impact on the economy. However, one needs to look at a more complete picture. The purpose of this article is a comprehensive analysis of the short run macroeconomic effects of remittances and impact of remittances on consumption, labor productivity, investment and economic growth.

Aggregate demand will be affected directly as increase in remittances will subsequently raise the purchasing power of remittance receiving‐households. While majority of remittances are consumed, part of this will be spent on traded goods due to which imports will rise. The increased demand for non‐traded goods will resultantly push up their prices. The surge in the price of non‐traded goods will then increase the domestic cost of production.

 

Remittances may also result in appreciation of the exchange rate which could, in turn, be detrimental for the exporters. Liquidity in financial markets will increase due to higher remittance flows which may push down the interest rate and lead to an expansion of credit. The lower interest rate may invite an increase in expenditure. Due to availability of limited avenues, increased investment of remittances in real estate or the stock market can push up asset prices which may exert a wealth effect. The total demand impact of an increase in remittances is the sum of these various effects: the direct expenditure effect, the multiplier effect and the interest rate effect will have a positive impact while the exchange rate appreciation could have a negative impact.

Another effect of increase in remittances is reduced labor force participation which increases the level of minimum wages at which members of migrant families’ are willing to work. Moreover, households receiving remittances may utilize the higher income to reduce work effort and increase luxury spending or education, which will further reduce the labor supply. The reduction of the labor supply may lead to an increase in the wage level, which will increase production cost and erode competitiveness.

The increase in remittances will also have an effect on inflation. Thus the demand pressures generated by the higher expenditure will push prices upwards and adverse labor supply effect may push up wages while the exchange rate appreciation will reduce the domestic prices of imported goods. If the demand pressures dominate, inflation will increase.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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