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Friday, 8 May 2009

The importance of remittances...

A new IMF working paper finds that remittances are useful in reducing growth volatility, with the potential implication that the recent reduction in remittances associated with the global recession may be particularly debilitating to remittance recipient countries :

We have provided evidence that remittance flows have indeed contributed on average to reducing the volatility of GDP growth in remittance-receiving countries, even after controlling for a large number of other potential determinants of growth volatility and taking into account the possible effect that growth volatility may itself exert on remittance flows. This provides an important channel through which remittance inflows may affect both growth and welfare in remittance-receiving countries.

However, the evidence on the existence of threshold effects suggests that the stability enhancing effects of remittances appear to be achieved rather quickly, so whatever benefits may be associated with very large remittance flows, enhanced macroeconomic stability may not loom large among them. This emphasizes the importance of strengthening macroeconomic resilience through other means in countries that are very large recipients of remittances. Fortunately, remittance resources may themselves provide the means to do so, including possibly through broad-based taxation of consumption, increases in which have been financed in many countries from the remittance inflows. An efficient VAT with limited exemptions could net for the domestic government a substantial share of the resources received through remittance inflows by countries that are large remittance recipients. These resources could be used to boost the human capital of the domestic population by improving health and education services, to alleviate infrastructure bottlenecks, and to improve the business climate so as to maximize the spillover effects of remittance inflows to the broader economy.

Finally, in light of the preponderance of evidence that the current global economic turmoil may lead to a significant drop in remittance flows to developing and emerging economies, the question arises as to what could be the implication for the remittance-recipient economies. Moreover, what could governments in those countries do to mitigate the social and financial impact of such a drop in these flows? The evidence on the positive impact of remittance flows on output stability presented in this paper suggests that the slow down or drop in remittance flows are likely to increase the volatility of the output, which is likely to have adverse welfare effects in the remittance-recipient countries. First, the loss of income from remittances is likely to hit the poorest the hardest, as these flows are typically used to purchase consumption goods as well as to complement limited public social insurance. Second, with migrants losing their jobs in the host countries and returning home, this is likely to raise unemployment in the home country.

Governments in the affected countries — who may have relied on these flows to reduce poverty, provide insurance against consumption shocks to households, and to increase the tax revenue by raising the consumption of goods and services purchased by these households may now see these benefits evaporate. Unemployment pressures due to returning migrants, and the urgency to replace the remittance-funded insurance to recipient households will place pressure on these governments to look into their limited policy tool box to find ways to alleviate the economic and social pressures arising from the loss of these benefits. One possibility is for governments in remittance-dependent countries to step up their fiscal expenditures on social insurance. This, however, will not be an easy task, since some of these countries will be impacted by the slow down in the global demand for their exports, which is likely to depress government revenue and limit borrowing capacity. Also, fiscal expenditures and employment-generating initiatives undertaken by governments in remittance-sending countries could also help in this context, to the extent that these measures may lower the possibility of more migrants losing their jobs and then having to decrease their remittances or having to return to their home countries.

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