INWARD WORKERS’ REMITTANCES ANDREAL EXCHANGE RATES IN SOUTH ASIA, 

1980‐2011

Molonglo Theatre, Crawford School of Public PolicyNovember 4, 2013

Arjuna Mohottala

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011 2

Surge in remittances to developing countries over the past years

1998: US$ 50 bn

2012: US$ 406 bn (World Bank estimate)

Remittances are nearly 3 times the amount of ODA and almost on a par withFDI flows to developing countries

Many research focus on short-run socioeconomic impact

Existing research mostly focus on economic growth, industrialisation andfiscal sustainability

There could be macroeconomic effects such as appreciation of the realexchange rate in response to inward remittances.

BACKGROUND

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KEY LITERATURE

López, H, Molina, L & Bussolo, M 2007, ‘Remittances and the Real ExchangeRate’,World Bank Policy ResearchWorking Paper 4213.

Focus is on Latin American countries

Distributed lag model

Conclude remittances contribute to real exchange rate appreciation

Lartey, EKK, Mandelman, FS & and Acosta, PA 2008, ‘Remittances, exchangerate regimes, and the Dutch disease: a panel data analysis’, Working Paper2008-12, Federal Reserve Bank of Atlanta.

Generalised method of moments estimator

Period 1990 - 2003

Dutch disease is stronger in fixed exchange rate regimes

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

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RESEARCH QUESTION

Do inward workers’ remittances result in an appreciation of the real exchange rates in South Asia during 1980-2011?

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

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RESEARCH QUESTION

Pre-crisis period (2005-2008) witnessed a notable increase in migrant workers fromSouth Asia (World Bank)

South Asia is expected to have received $109 billion in remittances in 2012 (WorldBank)

Table 1 Summary statistics by country: 1980-2011

Country Total Remittances (USD mn) Remittances/GDP REER appreciation1980 2011 1980 2011 1980 - 2011 (%)

Bangladesh 338.67 12,050.62 1.9 10.8 -19.96%India 2,755.69 53,480.00 1.5 3.4 -25.48%Nepal 34.79 4,010.48 2.4 22.3 -13.24%Pakistan 2,047.62 12,235.00 8.6 5.8 -47.69%Sri Lanka 151.70 5,144.84 3.8 8.7 30.91%

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

Do inward workers’ remittances result in an appreciation of the real exchange rates in South Asia during 1980-2011?

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011 6

Balanced panel data set for the period 1980 - 2011

The countries included in the research:

Bangladesh

India

Nepal

Pakistan

Sri Lanka

Sources:

IFS and WDI databases

Nepal Rastra Bank

Darvas (2012) for REER index series

DATA

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HOW THE DATA LOOKS

Bangladesh India Nepal

Pakistan Sri Lanka Remittances growth

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

Figure 1: Remittances flows and REER of selected countries

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DETERMINANTS OF REAL EXCHANGE RATE

Table 2 Determinants of real exchange rate

Variable Definition Expected sign

Remittances Growth rate of remittances per capita ( + )

Exports Growth rate of exports per capita ( - )

Imports Growth rate of imports per capita ( + )

M2 growth Growth rate of broad money ( - )

Govt. expenditureAnnual growth of government consumption expenditure relative to GDP

( - )

GDP growth Growth rate of the GDP ( + )

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

ESTIMATION

η is an unobserved country-specific effect

λ is a time-specific effect

ε is the error term

9Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

COMPUTATION OF REER

where, is the nominal effective exchange rate of the countryunder study

is the nominal bilateral exchange rate

is is the geometrically weighted average of CPI indicesof trading partners

Darvas (2012) uses time-invariant weights

Basket of countries representative of foreign trade in 1998-2003

Base year for this index series is set as 2007

10Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011 11

TESTS

Checks for structural breaks in the remittances flows

Zivot-Andrews unit root test - structural break at an unknown point in time

Chow Test-2

0-1

00

1020

Gro

wth

rate

per

ann

um (%

)

1980 1984 1988 1992 1996 2000 2004 2008 2012

growth rate of reer mean growth rate

Figure 2: Remittances growth rate of selected countries

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011 12

TESTS

Tests to assess the stationary of the variables

augmented Dickey-Fuller test

Dickey-Fuller Generalised Leased Square test

Phillips-Perron test

Subsequent to the introduction of the structural break, the variables werestationary at I(0)

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011 13

TESTS

Correcting for the endogeneity of remittances

Instrumental variables

Conditioning variables

Estimation technique

No consensus regarding any of these tools has emerged in the literature onremittances

Pablo and Lopez (2008) highlight that longer time horizons may facilitate toobtain the ceteris paribus effect of trade performance on the growth rate ofREER

ESTIMATION RESULTS

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Table 3 Determinants of the real exchange rate, estimation results

Model Fixed-effects Random-effects OLSVariable Coefficient S.E. Coefficient S.E. Coefficient S.E.

lrem_pc 0.075** 0.027 0.159*** 0.031 0.075** 0.027lex_pc -0.37*** 0.049 -0.195*** 0.048 -0.37*** 0.049lim_pc 0.182** 0.062 -0.009 0.065 0.182** 0.062lrem_pc_br -0.011 0.013 -0.04** 0.012 -0.011 0.013gdp_gr 0.018** 0.006 0.019** 0.007 0.018** 0.006gov_ex_gdp 0.031** 0.007 0.014** 0.005 0.031*** 0.007m2_gr -0.001 0.002 -0.003 0.002 -0.001 0.002_cons 4.729*** 0.144 4.894*** 0.122 4.849*** 0.126N 159 159 159r2 0.2527 0.3361 0.5840legend: * p<0.05; ** p<0.01; *** p<0.001

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

ESTIMATION RESULTS

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Table 4 Country-specific estimation results

CountryBangladesh India Nepal Pakistan Sri Lanka

Variable

lrem_pc -0.179* -0.046 0.228*** 0.209*** 0.249**

(S.E.) (0.074) (0.065) (0.064) (0.063) (0.1)

lrem_pc_br 0.011 0.025 -0.124 -0.092*** -.016

(S.E.) (0.022) (0.028) (0.046) (0.029) (0.017)

legend: * p<0.10; ** p<0.05; *** p<0.01

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

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The research looks at a long-term time horizon of 3 decades 1980-2011

The remittances flows to South Asia will continue to grow

Estimated results imply that a 1% increase in remittances per capita appreciates thereal exchange rate on average by 0.12% in South Asia over the time horizon

Developing countries in South Asia should aim to keep the REER close to itsequilibrium level

reinforces the need to have sound macroeconomic policies

Country specific results are different Data reflects Bangladesh’s REER depreciating on average 0.18% p.a.

Since 2002, Pakistan’s REER depreciates on average by 0.09% p.a.

Government expenditure to GDP shows a positive impact - different sign fromwhat is indicated in literature

CONCLUSION

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011

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Include more variables such as FDI , aid and financial flows

Encompass a Panel IV to mitigate the effects of causation

Need more micro-level studies for a clear explanation of the obtained result

CONCLUSION ‐ FUTURE RESEARCH

Arjuna Mohottala - Inward Workers’ Remittances and Real Exchange Rates in South Asia, 1980-2011