A remittance is the transfer of money by expatriates to their home countries. According to the World Bank, more than $550 billion is sent home annually in form of remittances across the globe. Nevertheless, this number has grown tremendously in the last decade due to the liberal migration laws between developed and developing countries and the ease at which money can be transferred with minimal transaction costs. Developing economies such as India and China are the biggest recipients of remittances, receiving an average of $65 billion annually. Remittances to Latin America and the Caribbean mostly come from their northern neighbor, the United States.
The Role of Remittances in the Economy
Remittances play a vital role in developing the economic systems of a country. At the national level, remittances are recognized as part of a country’s GDP and aid in promoting economic variables such as savings, investment, consumption, and income distribution. They supplement the national income by raising national savings, investments, and providing hard currency to finance imports, thus decreasing a balance of payments (BOP) deficit. Remittances bear no interest and their consumption is not tied to explicit investment projects with high import content. Consequently, this contributes positively towards economic stability by lowering the probability of current account reversals. In the recent past, the World Bank has considered a country's remittances as a factor when determining its credit score.
Remittances provide the receiving country with foreign exchange, which is a more stable and reliable source of foreign exchange earnings compared to Foreign Direct Investments or aid flows. Likewise, it serves to alleviate an economic downturn resulting from macroeconomic shocks such as debt crisis, political instability, natural disasters, and the balance of payments that are synonymous with developing countries, thus creating economic stability. In countries like Nepal, Pakistan, and Bangladesh, it is estimated that the amount received in form of remittances annually exceeds national foreign exchange reserves.
Remittances play a vital role in social welfare by helping in poverty reduction, investments, savings, and development. This case is based on the fact that most recipients of remittances are low-income families and individuals who use the money for personal development, education, and investments. With increased disposable income, their consumption and savings also increase. Moreover, expatriates also desire to invest in their home countries through investments in the real estate and bond markets. In return, these investments trigger the demand for complementary good and services in the national market.
On the other hand, remittances have no effect on the economic growth of a country in the medium and long-term. Remittances are a known cause of inflation as they appreciate the real exchange rate and reduce participation in the labor market, as the receiving households tend to live off the expatriate. They hinder economic development since the short-term reduction in poverty slows down the implementation of structural reforms in the economy to alleviate the problem in the long-run. In addition, savings from remittances are mostly used to purchase non-productive assets, which have no contribution to economic growth for the receiving country. These inflows can thereby create disastrous economic shocks on countries that depend heavily on them in the event that the flow of remittances is disrupted.