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Leveraging remittances for development

The Reserve Bank of Zimbabwe Deputy Governor Dr Kupukile Mlambo delivered a very good presentation which showcased the state of the financial sector and liquidity position.

In his presentation, he highlighted diaspora remittances as second key source of liquidity after exports.

What was clear was that if we get our formula right we can address liquidity crisis on the back of increase in remittances.

In this discussion and subsequent weeks I will provide discourse on issues surrounding diaspora remittances.

Although most of the statistics are outdated as they date back to 2006 they still provide useful insights on the role of remittances on development.

Remittances received from migrants abroad are one of the largest sources of external finance for developing countries.

In 2006, recorded remittances sent home by migrants from developing countries reached $206 billion, up from $193 billion in 2005 and more than double 2001’s level.

The true size of remittances, including unrecorded flows through formal and informal channels, is believed to be even larger.

They are almost as large as foreign direct investment, and more than twice as large as the official aid received by developing countries.

The doubling of recorded remittances over the past five years is a result of a combination of factors: better measurement of flows; increased scrutiny since the terrorist attacks of September 2001; reduction in remittance costs and expanding networks in the money transfer industry; depreciation of the US dollar (raising the dollar value of remittances in other currencies); and growth in the migrant stock and incomes.

Poor countries receive relatively larger remittances

In 2006, according to World Bank, the top three recipients of remittances – India, China, and Mexico – each received nearly $25 billion.

As noted by World Bank, smaller and poorer countries tend to receive relatively larger remittances in proportion to the size of their economies. Expressing remittances as a share of GDP, the top recipients were Moldova (30 percent), Tonga (27 percent), Guyana (22 percent), and Haiti (21percent).

Remittances are thus more evenly distributed across developing countries than are private capital flows.

Remittances are stable or even countercyclical

Remittances tend to be more stable than private capital flows, and may even be countercyclical relative to the recipient economy.

Evidence shows that remittances tend to rise when the recipient economy suffers a downturn in activity, an economic crisis, natural disaster, or political conflict, as migrants may send more funds during hard times to help their families and friends.

For example, remittances rose during the financial crisis in 1995 in Mexico and in 1998 in Indonesia and Thailand.

They also increased following hurricanes in Central America. In Somalia and Haiti, they have provided a lifeline for the poor.

In addition to bringing the direct benefit of higher wages earned abroad, migration helps households diversify their sources of income and thus reduce their vulnerability to risks.

Remittances reduce poverty

Remittances directly augment the income of recipient households. In addition to providing financial resources for poor households, they affect poverty and welfare through indirect multiplier effects and also macroeconomic effects.

These flows typically do not suffer from the governance problems that may be associated with official aid flows. Regression analysis across countries worldwide shows the significant poverty reduction effects of remittances: A 10 percent increase in per capita official remittances may lead to a 3,5 percent decline in the share of poor people. Recent research indicates that remittances reduced poverty in sub-Saharan

Africa and Latin America, although with effects that vary across countries. Household survey data show that remittances have reduced the poverty headcount ratio (percent of population below the national poverty line) significantly in several low income countries – by 11 percentage points in Uganda, 6 percentage points in Bangladesh, and 5 in Ghana.

In Nepal, remittances may explain a quarter to a half of the 11 percentage-point reduction in the poverty headcount rate over the past decade (in the face of a difficult political and economic situation).

The analysis of the poverty impact of remittances must take into account the loss of income that the migrant may experience due to migration (for example, if the migrant has to give up his or her job).

Such losses are likely to be small for the poor and unemployed but large for the middle- and upper income classes.

Very poor migrants may not be able to send remittances in the initial years after their migration.

Also, the remittances of very rich migrants may be smaller than the loss of income due to migration.

But for the middle-income groups, remittances enable recipients to move up to a higher income group.

In Sri Lanka, for example, households from the third through the eighth income decile moved up the income ladder due to remittances.

Remittances finance education, health, and entrepreneurship

Remittances are associated with increased household investments in education, entrepreneurship, and health – all of which have a high social return in most circumstances. Studies based on household surveys in El Salvador and Sri Lanka find that children of remittance-receiving households have a lower school dropout ratio and that these households spend more on private tuition for their children.

In Sri Lanka, the children in remittance-receiving households have higher birth weight, reflecting that remittances enable households to afford better health care. Several studies also show that remittances provide capital to small entrepreneurs, reduce credit constraints, and increase entrepreneurship.

Leveraging remittances for development

Governments in destination and origin countries can facilitate remittance flows and enhance their development impacts through the application of appropriate policies. However, some current policy practices pose pitfalls.

Almost all developing countries offer tax incentives to attract remittances, but such tax exemptions on remittances may encourage tax evasion.

Matching-fund programs (such as Mexico’s 3-for-1 program, in which the municipal, state, and national governments match migrant organizations’ investments in development) may effectively leverage small volumes of collective remittances from migrant associations for small community development projects, but such programs may not be scalable and may divert funds from other local funding priorities.

Efforts to channel remittances to investment have met with little success. Instead, efforts should be made to improve the overall investment climate in the origin countries.

Some governments have been toying with the idea of taxing remittances. This would have an effect similar to that of raising remittance costs and would hurt the poor migrants and their families in origin countries.

Taxation would also drive remittance flows further underground. Remittances should not be viewed as a substitute for official development aid.

Fundamentally, they are private money that should not be expected to fund public projects. Not all poor households receive remittances; official funding is necessary to address the needs of such households.

Leveraging remittances for the financial access of migrants and their beneficiaries

Encouraging remittances through banking channels can improve the development impact of remittances by encouraging more saving and enabling better matching of saving with investment opportunities.

Remittances received as cash are less likely to be saved than those received through a bank account.

For many poor households and migrants, remittances are the only point of contact with the formal financial sector.

By providing remittance services, banks and other financial institutions can attract new customers for their deposit and loan products. Micro-finance institutions can use the history of remittance receipts to judge the credit history of potential customers.

Remittances are almost as large as foreign direct investment, and more than twice as large as official aid received by developing countries.

Both sending and receiving countries can increase migrants’ banking access by allowing origin country banks to operate overseas and providing identification cards (such as the Mexican matrícula consular), which are accepted by banks to open accounts.

Access to remittance services in rural and remote areas can be improved by encouraging the participation of micro-finance institutions, credit unions, and saving banks (including postal saving schemes) in the remittance market.

Existing regulations may need to be amended to allow these institutions to more fully participate in providing remittance services.

In many countries, micro-finance institutions would need legal permission to receive foreign exchange.

In some cases, they may need limited access to national clearance and settlement systems.

Leveraging remittances for capital market access of financial intermediaries

Remittances can improve a country’s creditworthiness and thereby enhance its access to international capital markets.

Hard currency remittances, properly accounted, can significantly improve country-risk rating, and thereby lower their cost of borrowing money in international markets.

The ratio of debt to exports of goods and services, a key indebtedness indicator, would increase significantly if remittances were excluded from the denominator.

Model-based calculations using debt-to-export ratios that include remittances in the denominator indicate that including remittances in creditworthiness assessments would improve credit ratings for Lebanon and Haiti (by two notches) and result in implied sovereign spread (the difference in interest rates between a sovereign bond and comparable US treasuries) reductions ranging from 130 to 334 basis points.

Future flows of remittances can be used as collateral to improve the rating of commercial (sub-sovereign) borrowers.

Several banks in developing countries (such as Brazil, Egypt, El Salvador, Guatemala, Kazakhstan, Mexico, and Turkey) have been able to raise cheaper and longer-term financing (more than $15 billion since 2000) from international capital markets via the securitisation of future remittance flows.

By mitigating currency convertibility risk, a key component of sovereign risk, the future flow securitisation structure allows securities to be rated better than the sovereign credit rating. In the case of El Salvador, for example, the remittance-backed securities were rated investment grade, two to four notches above the sub-investment grade sovereign rating.

Investment grade rating makes these transactions attractive to a wider range of “buy-and-hold” investors (for example, insurance companies) that face limitations on buying sub-investment grade.

As a result, the issuer can access international capital markets at a lower interest rate spread and longer maturity.

Moreover, by establishing a credit history for the borrower, these deals enhance the ability and reduce the costs of accessing capital markets in the future.

Reducing remittance costs

Reducing remittance fees would increase the disposable income of poor migrants, boost their incentives to send more money home, and encourage the use of formal remittance channels.

The cost of sending remittances tends to be high and regressive. A typical poor migrant sends about $200 or less per transaction.

The average cost through the top three money transfer operators (Western Union, MoneyGram, and Dolex) can be as high as $16 for $100 and $18 for $200.

These fees are highly regressive because the smaller remittances sent by poor migrants cost more per dollar sent.

With increased awareness among policymakers and migrants, and due to the falling costs of technology, remittance costs have been declining in recent years. In the US – Mexico corridor, for example, the cost of sending $300 fell by 54 percent between 1999 and 2004, from more than $26 to $12.

Since then, however, costs have remained sticky, dropping only to $10,60 by the end of 2006.

  • Dr Mugano is an Author and Expert in Trade and Competitiveness. He is a Research Associate at Nelson Mandela Metropolitan University and a Senior Lecturer at the Zimbabwe Ezekiel Guti University. Feedback: Email: gmugano@gmail.com, Cell: +263 772 541 209.
Source :

herald

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