THE MACROECONOMIC IMPACT OF REMITTANCES IN DEVELOPING COUNTRIES. Ralph CHAMI Middle East and Central Asia Department The International Monetary Fund

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1 SINGLE YEAR EXPERT MEETING ON MAXIMIZING THE DEVELOPMENT IMPACT OF REMITTANCES Geneva, February 2011 THE MACROECONOMIC IMPACT OF REMITTANCES IN DEVELOPING COUNTRIES By Ralph CHAMI Middle East and Central Asia Department The International Monetary Fund

2 Outline What constitutes Remittances? Stylized Facts Determinants of Remittances The Macroeconomic Effects of Remittances Policy Implications for Remittance- Dependent Economies Implications of the crisis

3 I. Measurement Matters Private, Unrequited Income Transfers from Migrants to Family Members Back Home The category workers remittances in the balance of payments best represents what economists have in mind when modeling remittances The properties of this series differ significantly from employee compensation and migrants transfers Figures only include remittances sent through official and measurable channels

4 II. Stylized Facts Remittances are large worldwide and growing, and are substantial for individual countries.

5 II. Stylized Facts Remittances are large in relation to GDP Developing Countries: Workers' Remittances (in percent of GDP) Mean workers' remittances to GDP ratio across countries and time Maximum workers' remittances to GDP ratio across countries and time Number of countries Number of observations 3,471 1, Cross country standard deviation Source: World Bank WDI Database, International Monetary Fund WEO Database, and authors' calculations.

6 II. Stylized Facts and to other flows into developing countries Developing Countries: Workers' Remittances in Relation to Selected Balance of Payments Inflows Official Transfers Ratio of Workers' Remittances to Official Capital Flows Private Capital Flows Exports Recent period, Mean across countries and time Maximum country average Cross country standard deviation Recent observation: 2010 Mean Maximum Cross country standard deviation Sources: World Bank WDI Database, International Monetary Fund WEO Database, and authors' calculations.

7 Average Workers Remittances by Region (in billions of USD)

8 II. They are Stable Flows II. They are Stable Flows Volatility of Flows to Developing Countries ( )

9 What Motivates Remittances? Negative relationship w.r.t. home country income.compensatory Positive relationship w.r.t. income abroad Insensitive to interest rate differentials Insensitive to exchange rate differentials They are NOT private capital flows; they are neither procyclical nor profit-driven

10 Microeconomic Impact Well studied Household surveys and formal analysis Good News Alleviate Poverty: Raise consumption Buffer: Insure against income shocks Reduce labor supply for recipients Raise Welfare

11 III. Macroeconomic Consequences Not well studied Several important caveats and policy considerations that have largely been overlooked until recently The two main questions of interest to policymakers with regard to remittances are: How to manage the macroeconomic effects of remittances? How to harness the development potential of remittances?

12 A. Reduce Output Volatility (sd. dev of per capita output growth over 5 periods mean for each h group) Developing Asia Industrial countries MENA Africa Western Hemisphere

13 B. Raise Tax Revenue Remittances raise consumption of tradables and non-tradables Directly or indirectly expand tax base Raise Tax Revenue! Increase fiscal Space!

14 C. Improve Debt Sustainability Thereby reducing the marginal cost of raising revenue Remittances can lead to reduced country risk and Improve the sustainability of government debt

15 Beware News

16 D. Dutch Disease Effect Remittances may constitute a source of financing in the balance of payments Empirical evidence suggests that remittances are positively correlated with real exchange rate appreciation.. Dutch Disease Effect Appreciation effect stronger for low and lower middle- income countries However, among them, stronger for less open economies (to both trade and capital flows) Although appreciation effect is not very large economically!

17 E. Magnify Business Cycle Effects Higher output volatility Increased correlation between labor and output Higher taxes, debt, and/or money growth More labor taxes reinforce higher output volatility Tax remittances indirectly through consumption tax VAT! More volatile government policy But households care less (remittances insulate household from government policy choices)

18 F. Looser Fiscal Discipline Remittances may reduce the government s s incentive to maintain fiscal policy discipline The empirical evidence suggests that governments may take advantage of the fiscal space afforded by remittances by consuming and borrowing more

19 G. Reduce Governance Incentives Remittances may pose a moral hazard problem by reducing the political will to enact policy reform Remittances insulate households from government policy Reduce the households incentives to pressure the government to implement the needed reforms to facilitate economic growth Remittances can therefore delay needed upgrades to the public infrastructure by both reducing public demand for them and by reducing the likelihood of a crisis that would make such reforms necessary

20 H. No Impact on Economic Growth Remittances are not necessarily associated with an increase in domestic investment, or a more efficient allocation of domestic investment Remittance recipients rationally substitute unearned remittance income for labor income and, Since labor and capital are complementary goods in production, this negatively affects the rate of capital accumulation There is no statistically significant effect of remittances on GDP growth

21 III. Challenge for Policymakers Design policies that promote remittances and increase their benefits while mitigating adverse side effects Getting these policy prescriptions correct early on is imperative Globalization and the aging of developed economy populations will ensure that demand for migrant workers remains robust for years to come Hence, it is likely that the volume of remittances will continue to grow, and with it, the challenge of unlocking the maximum societal benefit from these transfers

22 Role for International Financial Institutions International financial institutions have an important role to play in encouraging remittance-receiving countries to undertake or accelerate necessary reforms A one-size size-fits-all reform strategy is likely to be counterproductive: An approach that differentiates among countries based on their remittance-driven characteristics will be more helpful in achieving its targets

23 Impact of Crisis on Remittance Flows Global slow down reduced remittances: Mexico, Philippines, MENA, Armenia, Tajikistan, etc. For remittance-dependent economies: Reduced household consumption Increased stress on an already weak or non- existent social safety net Raised poverty Reduced tax revenue Reduced government ability to sustain debt Reduced demand for imports Exacerbated an already severe unemployment problem back home

24 References Determinants and Fiscal Implications of Remittance flows in MENA region, (2011): Abdih,, Barajas, Chami,, and Ebeke Worker s s Remittances and the Equilibrium Real Exchange Rate, (2010): Barajas, Chami, Hakura,, and Montiel Do Workers Remittances Promote Economic Growth, (2009): Barajas, Chami, Fullenkamp,, and Montiel Fiscal Sustainability in Remittance-Dependent Countries, (2009): Abdih, Chami, Gapen,, and Matti On Remittances and Output Volatility, (2009): Chami, Hakura and Montiel Macroeconomic Consequences of Remittances, (2008):Chami, Barajas, Cosimano, Fullenkamp, Gapen,, and Montiel Remittances and Institutions: Are Remittances a Curse? (2008):Abdih, Chami, Dagher and Montiel Beware of Emigrants Bearing Gifts: Optimal Fiscal and Monetary Policy P in the Presence of Remittances, (2006): Chami, Cosimano and Gapen Are Remittance Flows a Source of Capital for Development? (2003): Chami, Fullenkamp and Jahjah

25 THANK YOU

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