Do Remittances Facilitate a Sustainable Current Account?

• Author: Gazi M. Hassan,Mark J. Holmes
• Date: 01 November 2016
• Published date: 01 November 2016
• DOI: http://doi.org/10.1111/twec.12361

Do Remittances Facilitate a Sustainable

Current Account?

Gazi M. Hassan and Mark J. Holmes

Department of Economics, University of Waikato, Hamilton, New Zealand

1. INTRODUCTION

REMITTANCES by immigrant workers are now an important source of funds for many

developing countries, and their inflows have been rapidly growing. According to the

World Bank, officially recorded remittances to developing countries are estimated to have

reached $414 billion in 2013, an increase of 6.3 per cent over the previous year. During 2007

and 2008, the growth rate in remittances was 15 per cent; Ra tha et al. (2009). Chami et al.

(2008) and Barajas et al. (2009) have reported that during 2007, remittances through official

channels were $300 billion in addition to unknown transfers through unofficial channels,

which are estimated to be about 40 per cent of flows through the official channels; the ratio

of remittances to GDP exceeds 1 per cent in 60 countries. Remittances sent home by migrants

to developing countries are now equivalent to more than three times the size of official

development assistance. Remittance costs have fallen steadily in recent years,

1

and despite the

current global economic weakness, remittance flows are expected to continue growing.

Although a significant proportion of these inflows are for altruistic reasons to support con-

sumption and the living standards of family members, some are also motivated by pecuniary

gains and take advantage of the incentives offered by the recipient countries.

2

Studies con-

cerning the macroeconomic impact of remittance flows have tended to predominantly focus

on areas related to economic growth, the volatility of output, financial sector development and

real exchange rate appreciation. The less controversial findings are that: (i) the steady flow of

remittances can reduce the volatility in output; see IMF (2005), World Bank (2006) and

Chami et al. (2008); (ii) remittances are developmental for the financial sector because they

contribute to the easing of the credit constraints on domestic investments; see Aggarwal et al.

(2006), Gupta et al. (2009) and Giuliano and Ruiz-Arranz (2009); and (iii) remittances lead to

an appreciation of the real exchange rate and hence come with a cost in terms of competive-

ness; see Amuedo-Dorantes and Pozo (2004), Acosta et al. (2007), Lopez et al. (2007),

Barajas et al. (2010) and Lartey et al. (2012). Although it seems only natural to expect that

inward remittances would contribute to economic growth by a faster accumulation capital,

there is only mixed evidence in support of this in the literature. The growth impact of

remittances ranges from it being positive to negative aside from being conditional as well as

We would like to acknowledge the helpful comments provided by an anonymous referee and participants

at the 2014 meeting of the New Zealand Association of Economists. Any remaining errors are our own.

1

Although the World Bank points out these costs remain high, especially in Africa and in small nations.

Globally, migrants pay an average cost of 9 per cent to send money home.

2

For example, deposits by the non-residents in India attract higher interest rates and are exempt from

income tax. Similarly, Pakistan and Bangladesh give incentives to increase remittances. In 2008, India’s

remittance receipts were the highest at US$52 billion. Other countries with high remittances include

China and Mexico.

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The World Economy (2016)

doi: 10.1111/twec.12361

The World Economy

indirect via other channels; see Chami et al. (2003, 2008), Catrinescu et al. (2009), Rao and

Hassan (2012) and Siddique et al. (2012).

A conspicuous omission from the previous literature is an analysis of the interaction

between remittances and the current account both conceptually and methodologically. The fact

that workers’ remittances flows are significantly less volatile and are more stable (IMF, 2005;

Ratha et al., 2 009) compared to other external flows such as private capital and fore ign aid

could possibly bear important macroeconomic consequences for the sustainability of the cur-

rent account which deserves detailed scrutiny. A number of studies have already considered

the relationship between remittances and current account stability. As pointed out by Sayan

(2004), high remittances shares imply a high degree of dependence on remittances as a source

of foreign exchange receipts. These high shares are a cause for concern, even though remit-

tances have been relatively more stable than private capital and foreign direct investment

flows. This is because the large remittances shares increase the capacity of swings in remit-

tance flows to produce fluctuations in current account balances, with serious macroeconomic

effects. Buch and Kuckulenz (2010) indicate the positive impact of worker remittances on the

current account as remittances provide both foreign exchange and additional savings for econ-

omic development. However, the literature also has emphasised a potential ‘Dutch dise ase’

effect that can deteriorate the economy’s payment position. Further insight is offered by

Bugamelli and Patern

o (2009) who show that workers’ remittances can reduce the probability

of a current account reversal and thereby reduce the probability of financial crises. Finally,

Singer (2010) reflects on the role of remittances as a determinant of the severity of trade-offs

involved with exchange rate regime choice.

The overarching implications of the large and steady flows of remittances are perhaps more

prominent in the context of sustainability of the current account which amounts to analysing

whether a country is able to satisfy its intertemporal budget constraint in the long run without

having to incur episodes of drastic and painful adjustment. A stationary current account is

consistent with sustainable external debts. However, developing countries tend to reject the

policy of curtailing imports to reduce current account deficits on the grounds that they stifle

growth and development objectives. Instead, they opt to fund widening current account bal-

ances through further borrowing, but this leads to unacceptably high debt service to exports

ratios. Current account deficits have therefore contributed to debt and a potential downward

spiral of negative basic transfer (loss of foreign exchange and a net outflow of capital), dwin-

dling foreign reserves and stalled development prospects (Holmes, 2006b). The accumulation

of current account deficits for prolonged periods may end either abruptly by generating debt

and exchange rate crises and output collapse, or by achieving a soft landing that would lead

to investment, consumption and growth slowdowns. However, a stationary or mean-reverting

current account might mean that painful adjustment will not be required. The crises-averting

role of remittances is therefore subsumed within the broader framework of the sustainability

of the current account. The existing literature has said little about this role of remittances and

has instead contributed more on the role of the exchange rate regime. While Gnimassoun and

Coulibaly (2014) and earlier work conclude that a floating exchange rate helps facilitate

current account adjustment or reversion, Chinn and Wei (2013) find that there is no such role.

In this paper, we instead propose to provide an additional new insight into what might

actually drive sustainability.

Achieving a sustainable current account balance is an important policy objective for an

open economy linked to world market, because it is consistent with the sustainability of

external debts implying that there is no incentive for a country to default on its international

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