Remittances: boon or bane for growth?–II

The Dutch Disease is characterized by a rapid increase in one sector at the cost of other sectors. Firstly, the income shock and subsequent spending increase can drive demand-pull inflation. For many developing countries, prices in tradables are determined largely by international markets.

However, the non-tradables’ sector is relatively more influenced by domestic demand. Pakistan already experiences higher inflation in the non-tradables’ sector (SBP, 2019) compared to tradables and the ‘spending effect,’ of remittances exacerbates that.

Remittances: boon or bane for growth?–I

The consequence of this demand and price shift is more factors are allocated from tradables towards non-tradables, otherwise known as the ‘resource movement effect.’ Therefore, increased factor prices, decreased tradables output, and overall increase in goods’ prices results in an appreciated currency.

Ultimately decreasing the competitiveness of export-oriented sectors, and widening the current account deficit. Such a phenomenon has been witnessed in many Latin American economies.

Similarly, a study in 2006 found that Pakistan’s exchange rate experienced growth in accordance with increased remittance inflows (Hyder and Mahboob, 2006). Which implies that there is a tradeoff between reliance on remittances and export-led growth.

Remittances also share a positive relationship with rising import bills. Studies conducted in 2007 and updated in 2019 found a significant and positive correlation between rising remittances and rising import bills (Hussain and Yan, 2019). These results align with investigations by Hernandez and Toledo on eight Latin American countries, where it was found that remittances increase imports. This creates another avenue towards the Dutch Disease, as a shift in the balance of trade towards imports weakens export competitiveness. However, this dynamic can be mitigated if resources are moved towards raising productivity in tradables.

Given the tenuous relationship between remittances and economic growth, it would help to explore how remittances can positively impact investments.

As previously stated, remittances have a negligible impact on investment growth in Pakistan. Research conducted in Bangladesh, which exhibits similar patterns of consumption and investment from remittances, has shown a non-linear relationship between remittance flows and economic growth in the long term (Hassan, 2017). In other words, remittances have diminishing returns and can eventually hurt growth potential in the long term if incentives for investment aren’t established.

Conversely, there may be a reverse causality, where better economic conditions are the precursor for remittance growth to translate into GDP growth.

In this regard, India stands as a positive example. Investigations by the World Bank and International Journal of Economic Policy Studies have shown that despite being the largest receiver of remittances globally, India has sidestepped the issue of dependency and translated remittance growth into economic growth.

This is due to the creation of financial infrastructure orbiting remittances specifically. The Reserve Bank of India has pushed for the proliferation of microfinancing, electronic banking, and community financing schemes especially in rural areas.

The Ministry of Overseas Indian Affairs also launched a series of schemes in 2009 that incentivize the diaspora to invest in Indian development programs with generous interest rates on remittance-linked loans.

Similarly, El Salvador’s Banco Salvaderno offers loans of up to 80% of the amount received via remittance. This motivates households to engage in capital accumulation, driving growth at the macro-level. These programmes all exist in tandem with projects that increase access to banking and financial services.

Pakistan can employ similar strategies to make productive use of this resource. Firstly, the government should invest in expanding financial accessibility. The State Bank of Pakistan estimates that 53% of the population is financially excluded. Thus, over half the population is unable to engage in formal investment.

Making bank accounts easier to open, introducing e-banking, and expanding rural access can all mitigate this problem. Secondly, transaction costs need to be reduced to make full use of remittance inflows.

There is considerable variability in costs for sending remittances through different countries. For example, sending money from Kuwait has a 1.66% cost but doing the same from Singapore has a 12.43% cost (UNDP, 2021). This decreases the potential earnings based on where the migrant is located. Similarly, there is variation based on medium of transaction.

There is no standardized fee amongst banks facilitating transfers, with some charging a fixed rate and others using a percentage system. Money Transfer Operators (MTOs) are also a source of inconsistency, as their integration with banks is still relatively low.

There is also the issue of regressive transaction costs, as it is 39% pricier to send $200 rather than $500 (UNDP, 2021). Data from the International Growth Center found that 43% of migrants are employed as low-skill labour in the Gulf states, and send small amounts in the range of $200 back to their families. When earnings are already low, marginal propensity to save is decreased.

These transaction costs restrict existing inflows from being used to their full potential. Thirdly and most importantly, the government must create incentives for investment.

Diaspora financing is a growing and innovative field of development economics. Policy recommendations and tools of diaspora financing are diverse and worth exploring for Pakistan. These include capital market instruments based on remittances in India and East Africa. Remittance-linked loan packages advertised towards the recipient can capture their interest, as is done in India.

Similarly, Ethiopia and Kenya managed to accumulate $400 million and $154 million respectively via the issuing of sovereign bonds targeted towards remittance senders.

Mexico was particularly innovative with its 31 and 11 financing scheme. In the 31 programme, state, municipal and local governments would match the funds sent by remittances to finance infrastructure projects, resulting in 31% of road infrastructure and 20% of energy infrastructure being aided by remittances. Under the 11 scheme, migrants could provide a business plan to apply for a matching three-year loan.

Instead of repaying the loan to the local government, part of their remittances were channeled towards the 31 infrastructure development projects. Other programs involved matching pre-existing enterprises looking for investors with either remittance senders or recipients, offering generous interest rates for those who chose to invest.

Pakistan can employ similar financing schemes, and direct remittances towards exporting industries or infrastructure that aids their competitiveness.

Remittances are and likely will remain a resource for Pakistan. However, if the government continues to use this inflow as a crutch, the gains will diminish. Instead, Pakistan should utilize remittances to promote investment into export-led industrialization. This would draw in foreign direct investment, expand employment, and reduce current account deficit on a sustainable basis. The panacea for Pakistan’s balance of payments crisis has always been and remains export-led growth.

(Concluded)

Copyright Business Recorder, 2023