I have read in many papers that remittances can lead to domestic currency appreciation. However, I am more interested if someone can point out balanced theories and arguments of how inflow of remittances can cause currency depreciation aside from only appreciation.
REMITTANCES DISTINGUISHED
One must differentiate types of remittances. Every government has remittances from abroad. This is part of receipts from income, aids, and the like. In additional, banking and financial institutions also received remittances from abroad. These remittances generally come in foreign currency that is valued at a higher rate than the local currency, i.e. remitting US dollars to India. The recipient would have to exchange the US dollar for the Indian rupees. A second type of remittances is the non-institutions. These remittances may come through trade, or remittance of interest or salaries earned from abroad. These two types of remittances produce different effect on the domestic currency.
REMITTANCE AND APPRECIATION OF CURRENCY
State institution remittances rarely has any effect on the local currency because the state (government) may keep the foreign currency for future use without exchanging (buying) the local currency. Other non-governmental institutions who receive the remittance as part of their normal business operations has to exchange the foreign currency denominated remittance to the local currency. This arguably removes the local currency from the local market. If the transaction is multiplied, it may cause local currency’s appreciation. However, this is only in theory. In practice, institutional remittance recipient would also want to hold foreign currency for their future transaction or security against local instability; they would exchange only what is necessary. Ironically, people would expect that currency appreciation from international remittance would cause local currency to rise. It real life, it rarely happens. It is the remittance of the “small” recipients that causes local market inflation.
REMITTANCE AND DEPRECIATION OF CURRENCY
Countries with many family members living abroad or having many workers working abroad and remitting money to the home country generally causes the local currency to depreciate. The causation is indirect. The depreciation of the local currency does not come from the exchanging of the remitted foreign currency for the local currency, i.e. buying the local currency thus taking it off circulation thus reducing M1, but the effect comes from excess money in hand by the recipient who are more willing to spend in the local market and, thus, causing local inflation. This effect comes from the propensity to spend by the people (remittance recipient). In the long run, local inflation coupled with the accessibility to highly valued foreign currency would
The government may response by its traditional means by increase interest rate hoping to control local inflation. This will create additional problem: capital available for local investment would become more expensive. People and businesses that are not in the remittance circle would be adversely affected.
EVIDENCE
Countries with people emigrated to developed economies generally receive remittances. A second type of remittance comes from people going to work abroad. These countries would experience problems described. If the economy is not large enough to blunt the effect, the ill effect of remittance can be detrimental. Countries, such as Cambodia, Laos and Vietnam have large expatriate communities overseas; these expatriates remit US dollar to the home countries. Local inflation is largely due to these remittances. The effect is more pronounced in small economies. India also has a large number of people working abroad and remitting money home; however, the sheer size of the Indian economy is large enough to absorb and neutralize the effect of inflation pressure from remittance and---thus it is under control. If one can differentiate the size of the economies when undertaking the study of this issue, one can overcome Bastiat’s paradox: seeing the unseen.
REAL EXCHANGE
No effect should be anticipated on the real exchange rate. Remittance generally has a limited effect upon well-defined pockets of the local economy. For that reason, it is controllable.
REMITTANCES DISTINGUISHED
One must differentiate types of remittances. Every government has remittances from abroad. This is part of receipts from income, aids, and the like. In additional, banking and financial institutions also received remittances from abroad. These remittances generally come in foreign currency that is valued at a higher rate than the local currency, i.e. remitting US dollars to India. The recipient would have to exchange the US dollar for the Indian rupees. A second type of remittances is the non-institutions. These remittances may come through trade, or remittance of interest or salaries earned from abroad. These two types of remittances produce different effect on the domestic currency.
REMITTANCE AND APPRECIATION OF CURRENCY
State institution remittances rarely has any effect on the local currency because the state (government) may keep the foreign currency for future use without exchanging (buying) the local currency. Other non-governmental institutions who receive the remittance as part of their normal business operations has to exchange the foreign currency denominated remittance to the local currency. This arguably removes the local currency from the local market. If the transaction is multiplied, it may cause local currency’s appreciation. However, this is only in theory. In practice, institutional remittance recipient would also want to hold foreign currency for their future transaction or security against local instability; they would exchange only what is necessary. Ironically, people would expect that currency appreciation from international remittance would cause local currency to rise. It real life, it rarely happens. It is the remittance of the “small” recipients that causes local market inflation.
REMITTANCE AND DEPRECIATION OF CURRENCY
Countries with many family members living abroad or having many workers working abroad and remitting money to the home country generally causes the local currency to depreciate. The causation is indirect. The depreciation of the local currency does not come from the exchanging of the remitted foreign currency for the local currency, i.e. buying the local currency thus taking it off circulation thus reducing M1, but the effect comes from excess money in hand by the recipient who are more willing to spend in the local market and, thus, causing local inflation. This effect comes from the propensity to spend by the people (remittance recipient). In the long run, local inflation coupled with the accessibility to highly valued foreign currency would
The government may response by its traditional means by increase interest rate hoping to control local inflation. This will create additional problem: capital available for local investment would become more expensive. People and businesses that are not in the remittance circle would be adversely affected.
EVIDENCE
Countries with people emigrated to developed economies generally receive remittances. A second type of remittance comes from people going to work abroad. These countries would experience problems described. If the economy is not large enough to blunt the effect, the ill effect of remittance can be detrimental. Countries, such as Cambodia, Laos and Vietnam have large expatriate communities overseas; these expatriates remit US dollar to the home countries. Local inflation is largely due to these remittances. The effect is more pronounced in small economies. India also has a large number of people working abroad and remitting money home; however, the sheer size of the Indian economy is large enough to absorb and neutralize the effect of inflation pressure from remittance and---thus it is under control. If one can differentiate the size of the economies when undertaking the study of this issue, one can overcome Bastiat’s paradox: seeing the unseen.
REAL EXCHANGE
No effect should be anticipated on the real exchange rate. Remittance generally has a limited effect upon well-defined pockets of the local economy. For that reason, it is controllable.
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