Did you know your remittances can stabilise your currency back home? Here’s how
Economics, explained: Here’s how remittances affect currency valuation, economic health
Dubai: If you are an expat who is used to remitting money home, your decision on when you choose to remit would have been based on how weak or strong your currency is back home. But did you know that your remittances collectively have had a big role to play in how strong your currency gets?
Studies have shown that remittances not only contributes to your home economy’s growth, it can also affect the volatility of a currency’s exchange rate by strengthening or weakening the currency that is being remitted. Let’s delve into this deeper.
When you travel overseas, one of the routines you become accustomed to is exchanging your currency for the local currency. Many people get surprised by the different amounts of local money they have once their currencies are turned in.
Clearly, fluctuating global currencies are a constant. While there can be plenty of ways to capitalise on the wide swings of currencies, as touched upon above, one of the common practical applications of currency volatility for an expat living abroad is being to remit more money home.
How remittance contributes to economic growth
Remittances have evidently grown at a rapid pace over the last three decades worldwide, as indicated by World Bank’s historical data. Moreover, the contribution of remittances towards economic growth have risen in all countries during the last ten years.
According to the World Bank, remittances are now the second largest monetary inflow for developing economies right behind foreign direct investment (FDI), and it represents a stable inflow of foreign currency for many small developing economies as well.
Such remittance-induced economic growth has been most dramatic in South Asia, more so in Nepal, Bangladesh and Pakistan. However, for a country like India, which is the top recipient of remittances in the world, as the economy’s already growing across sectors, remittance-induced growth is limited.
How does economic health impact remittance rates?
In an economy, some of the main factors that affect currency exchange rates are what is referred to as a country’s ‘balances of payments’, the rate of growth, and general stability.
A recent World Bank study investigates the long-run relationship between remittances and real economic growth in 80 developing countries with careful attention to the potential differential impact of remittances across countries.
On average, it found that a 10 per cent increase in remittance is associated with a 0.66 per cent permanent increase in economic growth (GDP). Now let’s dig a bit deeper into how remittances affect currency movements and why.
“Remittances sent in US dollars typically require exchange into domestic currencies. Banks are able to increase their foreign reserves through this process of exchange, and maintain demand for the national currency,” explained Anil Pillai, a UAE-based banking analyst specialised in forex payments.
“Foreign reserves allow countries to stabilise their currencies to a greater degree during periods of crisis. This is a primary reason that affects the direction of currency movements both in the near and long-term.”
What are economic triggers impact remittance rates?
In economies with high levels of what is referred to as ‘partial dollarisation’, economists worldwide have flagged in multiple studies how an economy’s dependence on both foreign and local currency may translate to greater sensitivity of exchange rates to changes in foreign exchange inflows.
While ‘full dollarisation’ is when a country abandons its own currency and adopts another country's currency as a means of payment, ‘partial or de facto dollarisation’ occurs when a country keeps its own currency in circulation, but also allows payments and transactions to in US dollars.
According to the International Monetary Fund (IMF), there are only a handful of fully dollarised economies in the world, including Ecuador, El Salvador, and Panama. But ‘de facto or partial dollarisation’ is widespread to at least 100 countries worldwide.
“‘Partially dollarised’ economies experience better exchange rates due to inflows of remitted funds. For ‘highly dollarised’ economies with significant inflows of remittances, central banks will closely monitor how remittances impact currency markets,” added Pillai.
“With sizable remittance inflows, foreign currency can mitigates the size of short-term exchange rate moves. So by keeping a regular stream of foreign currency into a ‘dollarised’ economy, remittances stabilise exchange rate volatility under conditions when other sources are decreasing.”
How currency valuation affects your decisions to remit
When you’re looking to remit money back home, and deciding how much you want to send, the level of the exchange rate obviously matters because you would take into account the value of the currency back home when you remit.
“From an expat’s perspective, an appreciation of the currency back home can reduce how much money is remitted because it presents a form of the cost for the remitter,” explained Amit Trivedi, UAE-based long-time forex analyst and trader.
“Even so, remittances might increase following an appreciation of the currency when the remitter targets a specific and stable quantity of money. Thus, it can be noted that remittances expressed in the sending country currency increase with the appreciation of receiving country currency.”
Depreciation of a currency evidently helps bring in remittances. In India, for instance, where remittances makes up nearly 25 per cent of total foreign exchange reserves in the country, the depreciation of the Indian rupee always has a positive impact on the remittances.
The country has witnessed 50 to 80 per cent growth in remittance activity from several nations, particularly the Gulf, during the recent months. A similar trend occurred in 2012, 2013 and 2014 when the rupee witnessed a sustained depreciation.
From an expat’s perspective, an appreciation of the currency back home can reduce how much money is remitted because it presents a form of the cost for the remitter
Key takeaways
Roughly about $800 billion (Dh3 trillion) is remitted worldwide, according to the World Bank. Given the sheer size of these money transfers, it was widely expected that remittances would have a significant macroeconomic effects on the countries that receive them.
However, there is empirical evidence that remittances contribute to economic growth, through their positive impact on consumption, savings, and investment. As per an IMF study, remittances can also stabilise overall demand in the remittance recipient economy, which in turn contributes to growth.
Additionally, according to a similar study by World Bank, remittances have historically remained largely steady during episodes of financial volatility in several developing economies, which proves that they can play a stabilising role during economic fluctuations.
“While it’s difficult to track how remittance funds are spent as they are private transfers used to purchase necessities, economists widely agree that funds from abroad still help develop a domestic financial system, which indirectly contributes to a country’s development,” noted Trivedi.
“Also, large inflows in foreign currency can cause the domestic currency to appreciate, often referred to as ‘Dutch Disease’, and particularly help stabilise an economy’s currency when it is in decline. So, yes, your remittances do play a role in an economy’s growth and its currency.”