Policy Brief

PROGRAM ON MIGRANTS, MIGRATION, AND DEVELOPMENT

JUNE 2007

SUMMARY Migrant remittances are the most tangible Leveraging and perhaps the least controversial link between migration and development. Remittances for Remittances have become a major source of external development finance. In 2006, recorded remittances sent home by Development migrants from developing countries reached $206 billion, more than double the level in 2001.The true scale of remit- tances, including unrecorded flows Dilip Ratha through formal and informal channels, is believed to be even larger. Migrant remittances are the most tangible and perhaps the Remittances provide a convenient angle least controversial link between migration and develop- for approaching the complex migration ment. They can play an effective role in reducing poverty, agenda.They play an effective role in reducing poverty. Since remittances are and they provide a convenient angle for approaching the personal flows from migrants to their complex migration agenda. friends and families, they tend to be well targeted to the needs of the recipients. And these flows typically do not suffer Remittances are personal flows of money from migrants to from the governance problems that may their friends and families and should not be taxed or direct- be associated with official flows. ed to specific development uses. Instead, the development Remittances should not be taxed or direct- community should make remittance services cheaper and ed to specific development uses. Instead, more convenient and indirectly leverage these flows to the development community should make remittance services cheaper and more con- improve the financial access of migrants, their beneficiar- venient and indirectly leverage these flows ies, and financial intermediaries in the origin countries. to improve the financial access of migrants, their beneficiaries, and the financial inter- mediaries in the origin countries. The Growing Importance of Remittances A strong flow of remittances can also and Their Impact on Development improve the receiving country's credit- worthiness, lowering their cost of borrow- Remittances received from migrants abroad are one of the ing money in international markets.A research and policy agenda to maximize largest sources of external finance for developing coun- the development impact of international tries. In 2006, recorded remittances sent home by migrants remittances would include the following from developing countries reached $206 billion, up from four elements: a) monitoring, analysis, and projection; b) retail payment systems; c) $193 billion in 2005 and more than double 2001’s level financial access of individuals or house- (Table 1). The true size of remittances, including unrecord- holds; and d) leveraging remittances for ed flows through formal and informal channels, is believed capital market access of financial institu- tions or countries. to be even larger. They are almost as large as foreign direct Table 1. Global Flows of International Migrant Remittances (US$ billion)

Source: staff calculations based on IMF Balance of Payments Statistics Yearbook 2007. Remittances are defined as the sum of workers' remittances, compensation of employees, and migrant transfers. The complete dataset including country specific information is available at www.worldbank.org/prospects/imigrationsandremittance.

investment, and more than twice as large as Poor Countries Receive the official aid received by developing coun- Relatively Larger Remittances tries (Figure 1). In 2006, the top three recipients of remit- tances—, China, and Mexico—each The doubling of recorded remittances over received nearly $25 billion (Figure 2). But the past five years is a result of a combina- smaller and poorer countries tend to receive tion of factors: better measurement of flows; relatively larger remittances in proportion to increased scrutiny since the terrorist attacks the size of their economies. Expressing of September 2001; reduction in remittance remittances as a share of GDP, the top recipi- costs and expanding networks in the money ents were (30 percent), Tonga (27 transfer industry; depreciation of the US dol- percent), Guyana (22 percent), and Haiti (21 lar (raising the dollar value of remittances in percent). Remittances are thus more evenly other currencies); and growth in the migrant distributed across developing countries than stock and incomes. are private capital flows.

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Figure 1. Remittances and Capital Flows to Developing Countries

Source: Author's calculation based on Global Development Finance 2007 and IMF Balance of Payments Statistics Yearbook 2006.

Remittances Are Stable Somalia and Haiti, they have provided a life- or Even Countercyclical line for the poor. In addition to bringing the Remittances tend to be more stable than pri- direct benefit of higher wages earned abroad, vate capital flows, and may even be counter- migration helps households diversify their cyclical relative to the recipient economy. sources of income and thus reduce their vul- They tend to rise when the recipient econo- nerability to risks. my suffers a downturn in activity, an econom- ic crisis, natural disaster, or political conflict, Remittances Reduce Poverty as migrants may send more funds during Remittances directly augment the income of hard times to help their families and friends. recipient households. In addition to providing Remittances rose during the financial crisis financial resources for poor households, they in 1995 in Mexico and in 1998 in Indonesia affect poverty and welfare through indirect and Thailand (Figure 3). They also increased multiplier effects and also macroeconomic following hurricanes in Central America. In effects. These flows typically do not suffer

3 Figure 2.Top Recipients of Remittances,2006

Source: Author's calculation based on IMF Balance of Payments Statistics Yearbook 2007, World Development Indicators 2007, and World Bank Development Prospects Group data.

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Figure 3. Remittances Rise during Crisis, Natural Disaster or Conflict

Source: World Bank (2005) from the governance problems that may be income countries—by 11 percentage points associated with official aid flows. in Uganda, 6 percentage points in Bangladesh, and 5 in Ghana. In Nepal, Regression analysis across countries world- remittances may explain a quarter to a half of wide shows the significant poverty reduction the 11 percentage-point reduction in the effects of remittances: A 10 percent increase poverty headcount rate over the past decade in per capita official remittances may lead to (in the face of a difficult political and eco- a 3.5 percent decline in the share of poor nomic situation). people. Recent research indicates that remit- tances reduced poverty in sub-Saharan The analysis of the poverty impact of remit- Africa and Latin America, although with tances must take into account the loss of effects that vary across countries. income that the migrant may experience due to migration (for example, if the migrant has Household survey data show that remittances to give up his or her job). Such losses are have reduced the poverty headcount ratio likely to be small for the poor and unem- (percent of population below the national ployed but large for the middle- and upper- poverty line) significantly in several low- income classes.

5 Very poor migrants may not be able to send preneurship, and health—all of which have a remittances in the initial years after their high social return in most circumstances. migration. Also, the remittances of very rich Studies based on household surveys in El migrants may be smaller than the loss of Salvador and Sri Lanka find that children of income due to migration. But for the mid- remittance-receiving households have a dle-income groups, remittances enable lower school dropout ratio and that these recipients to move up to a higher income households spend more on private tuition for group. In Sri Lanka, for example, house- their children. In Sri Lanka, the children in holds from the third through the eighth remittance-receiving households have higher income decile moved up the income ladder birth weight, reflecting that remittances due to remittances (Figure 4). enable households to afford better health care. Several studies also show that remit- Remittances Finance Education, tances provide capital to small entrepre- Health, and Entrepreneurship neurs, reduce credit constraints, and Remittances are associated with increased increase entrepreneurship. household investments in education, entre-

Figure 4. Remittances Help Reduce Poverty

Source: De and Ratha (2006) * A negative number indicates the percentage of households that moved down to a lower income decile.

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Remittances May Cause act as a substitute for financial development. Currency Appreciation On the other hand, large outflows of workers Large remittance inflows, like any other for- (especially skilled workers) can reduce eign currency inflows, can cause an appreci- growth in countries of origin. Remittances ation of the real exchange rate and raise the may also induce recipient households to international price of traditional exports choose more leisure than labor, with adverse while making imports more expensive. effects on growth. Although empirical evidence of such “Dutch disease” effects of remittances is still lack- Remittances may be more effective in a good ing, the impact is likely to be large in small policy environment. For instance, a good economies. Several countries, including El investment climate with well-developed Salvador, Kenya, and Moldova, are concerned financial systems and sound institutions is about the effect of large remittance inflows likely to insure that a larger share of remit- on currency appreciation. tances is invested in physical and human capital. Remittances may also promote The traditional “sterilization” technique financial development, which in turn can used to prevent currency appreciation due to enhance growth. natural resource windfalls, however, is not appropriate for addressing the currency Empirical evidence on the growth effects of appreciation due to remittances. Unlike oil remittances, however, remains mixed. In windfalls, remittances persist over long peri- part, this is because the effects of remit- ods. Trying to sterilize their impacts year tances on human after year can be very costly. Countries have and physical capi- Unlike oil windfalls, to learn to live with these persistent flows. tal are realized remittances persist over long Government spending on infrastructure and over a very long efforts to raise labor productivity can to time. This is also periods. Trying to sterilize some extent offset the currency appreciation partly due to the their impacts year after year effects of remittances. difficulty associat- can be very costly. Countries ed with disentan- have to learn to live with The Effect of Remittances gling remittances’ on Growth Is Mixed countercyclical these persistent flows. To the extent that remittances finance educa- response to tion and health and increase investment, growth, which implies that the causality runs remittances could have a positive effect on from growth to remittances, when in fact the economic growth. In the economies where the correlation between the two variables is neg- financial system is underdeveloped, remit- ative. Finding appropriate instruments for tances may alleviate credit constraints and controlling such reverse causality is a chal-

7 lenge. It would be easy to conclude that countries. Some governments have been toy- remittances have a negative effect on growth, ing with the idea of taxing remittances. This but that would be erroneous. Also, to the would have an effect similar to that of raising extent that they increase consumption, remit- remittance costs and would hurt the poor tances may raise individual income levels migrants and their families in origin coun- and reduce poverty, even if they do not tries. Taxation would also drive remittance directly impact growth. flows further underground.

Leveraging Remittances Remittances should not be viewed as a for Development substitute for official development aid. Fundamentally, they are private money that Governments in destination and origin coun- should not be expected to fund public proj- tries can facilitate remittance flows and ects. Not all poor households receive remit- enhance their development impacts through tances; official funding is necessary to the application of appropriate policies. address the needs of such households. However, some current policy practices pose pitfalls. Almost all developing countries offer Leveraging Remittances for the tax incentives to attract remittances, but such Financial Access of Migrants tax exemptions and Their Beneficiaries Remittances are almost as large on remittances Encouraging remittances through banking may encourage as foreign direct investment, channels can improve the development tax evasion. and more than twice as large impact of remittances by encouraging more saving and enabling better matching of as official aid received by Matching-fund saving with investment opportunities. developing countries. programs (such as Mexico’s 3- Remittances received as cash are less likely for-1 program, in which the municipal, state, to be saved than those received through a and national governments match migrant bank account. organizations’ investments in development) may effectively leverage small volumes of For many poor households and migrants, collective remittances from migrant associa- remittances are the only point of contact with tions for small community development proj- the formal financial sector. By providing ects, but such programs may not be scalable remittance services, banks and other finan- and may divert funds from other local fund- cial institutions can attract new customers for ing priorities. Efforts to channel remittances their deposit and loan products. Microfinance to investment have met with little success. institutions can use the history of remittance Instead, efforts should be made to improve receipts to judge the credit history of poten- the overall investment climate in the origin tial customers.

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Both sending and receiving countries can may need limited access to national clear- increase migrants’ banking access by allow- ance and settlement systems. ing origin country banks to operate overseas and providing identification cards (such as Leveraging Remittances for the Mexican matrícula consular), which are Capital Market Access of accepted by banks to open accounts. Access Financial Intermediaries to remittance services in rural and remote Remittances can improve a country’s credit- areas can be improved by encouraging the worthiness and thereby enhance its access to participation of microfinance institutions, international capital markets. Hard currency credit unions, and saving banks (including remittances, properly accounted, can signifi- postal saving schemes) in the remittance cantly improve country-risk rating, and market. Existing regulations may need to be thereby lower their cost of borrowing money amended to allow these institutions to more in international markets. The ratio of debt to fully participate in providing remittance exports of goods and services, a key indebt- services. In many countries, microfinance edness indicator, would increase significant- institutions would need legal permission to ly if remittances were excluded from the receive foreign exchange. In some cases, they denominator (Figure 5). Model-based calcu-

Figure 5. Remittances Improve Country Creditworthiness

Source: World Bank (2005)

9 lations using debt-to-export ratios that insurance companies) that face limitations on include remittances in the denominator indi- buying sub-investment grade. As a result, the cate that including remittances in creditwor- issuer can access international capital mar- thiness assessments would improve credit kets at a lower interest rate spread and ratings for Lebanon and Haiti (by two notch- longer maturity. Moreover, by establishing a es) and result in implied sovereign spread credit history for the borrower, these deals (the difference in interest rates between a enhance the ability and reduce the costs of sovereign bond and comparable US treasur- accessing capital markets in the future. ies) reductions ranging from 130 to 334 basis points. Reducing Remittance Costs Reducing remittance fees would increase Future flows of remittances can be used as the disposable income of poor migrants, collateral to improve the rating of commer- boost their incentives to send more money cial (sub-sovereign) borrowers. Several banks home, and encourage the use of formal in developing countries (such as Brazil, remittance channels. Egypt, El Salvador, Guatemala, Kazakhstan, Mexico, and Turkey) have been able to raise The cost of sending remittances tends to be cheaper and longer-term financing (more high and regressive. A typical poor migrant than $15 billion sends about $200 or less per transaction. High remittance costs faced since 2000) from The average cost through the top three international capi- by poor migrants can be money transfer operators (Western Union, tal markets via the reduced by increasing access MoneyGram, and Dolex) can be as high as securitization of $16 for $100 and $18 for $200. These fees to banking and strengthen- future remittance are highly regressive because the smaller ing competition in the flows. By mitigat- remittances sent by poor migrants cost more remittance industry. ing currency con- per dollar sent. vertibility risk, a key component of sovereign risk, the future With increased awareness among policymak- flow securitization structure allows securities ers and migrants, and due to the falling costs to be rated better than the sovereign credit of technology, remittance costs have been rating. In the case of El Salvador, for exam- declining in recent years. In the US–Mexico ple, the remittance-backed securities were rated investment grade, two to four notches corridor, for example, the cost of sending above the sub-investment grade sovereign $300 fell by 54 percent between 1999 and rating. Investment grade rating makes these 2004, from more than $26 to $12. Since transactions attractive to a wider range of then, however, costs have remained sticky, “buy-and-hold” investors (for example, dropping only to $10.60 by the end of 2006.

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South–South remittance costs are even higher to provide cheaper remittance services than than North–South remittance costs (Figure 6). money transfer operators. Entry of new mar- Nearly half the migrants from the South live ket players can be facilitated by harmonizing in the South. Yet South–South remittances are and lowering bond and capital requirements, either impossible due to capital and exchange as well as avoiding overregulation such as controls, or they are prohibitively expensive requiring a full banking license for special- because currency conversion charges have to ized money transfer operators. be paid at both ends. Although anti-money-laundering regulations High remittance costs faced by poor and regulations that attempt to counter the migrants can be reduced by increasing financing of terrorism (AML/CFT) are neces- access to banking and strengthening compe- sary for security reasons, they should not tition in the remittance industry. Banks tend make it difficult for money service businesses

Figure 6. South-South Remittance Fees Are Higher than North-South Remittance Fees

*These fees are the average of Western Union and other agencies. **These fees and foreign exchange (FX) commissions are from Western Union only. Source: Ratha and Shaw (2007)

11 to operate accounts with correspondent banks. 1. Monitoring, analysis, and projection; These regulations are currently unclear, and 2. Retail payment systems; to make matters worse, they are not systematic 3. Financial access of individuals or or harmonized. Developing transparent com- households; and pliance guidelines on AML/CFT regulations 4. Leveraging remittances for capital should be a policy priority. market access of financial institutions or countries. Sharing payment systems would avoid dupli- cation of efforts. Establishing partnerships 1. Monitoring, analysis, and projection. between remittance service providers and This includes understanding the size, corri- existing postal and other dors, channels, and costs of remittance (and Remittances are retail networks would help migration) flows and the cyclical behavior of associated with expand remittance services these flows; analysis of remittances’ impacts increased household without requiring large on poverty, inequality, education, health, and fixed investments. However, investment in remittance-recipient countries; investments in exclusive partnerships and analysis of policy factors affecting remit- education, between post office net- tance costs—for example, entry barriers and entrepreneurship, works and money transfer exclusivity contracts affecting market compe- and health. operators have often result- tition and exchange controls affecting foreign ed in higher remittance fees exchange commissions. The effect of cost than when there are no such partnerships. reduction on size and channels of flows also Partnerships should be nonexclusive. falls under this heading.

Requiring greater disclosure of remittance 2. Retail payment systems. The changes fees from remittance service providers in the payment system relating to personal would help remitters make informed choic- remittances impact all retail or small-value es. Poor migrants would also benefit from payments, including person-to-business and financial education. business-to-business payments. The items in this category include new payment platforms Summary: The International or instruments (including cell phone-based, Remittances Agenda card-based, or Internet-based remittance instruments); prudential capital require- Remittances can contribute significantly to ments; and regulations governing access of poverty reduction and other UN Millennium remittance agents to clearing and settlement Development Goals. Following the discussion systems; compliance with anti-money laun- above, the international remittances agenda dering and attempts to counter the financing can be summarized under four headings of terrorism; disclosure of remittance fees; (Figure 7): and cross-border arbitration in the event that

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Figure 7. The International Remittances Agenda

a remittance transaction is not delivered as aging saving out of remittances, these finan- per the service agreement. cial intermediaries can develop remittance- linked consumer or housing loans and insur- 3. Financial access of individuals or ance products. They can also use the history households. While financial intermediaries of remittance receipt for evaluation of a such as banks, microfinance institutions, recipient’s creditworthiness. credit unions, and saving banks can help deliver remittance services, they can also 4. Leveraging remittances for capital benefit by offering remittance services that market access of financial institutions or may attract new customers and then encour- countries. Large and stable remittance flows age them to save and invest. Besides encour- undoubtedly improve a country’s creditwor-

13 thiness and thereby the creditworthiness of comparable plain sovereign bonds. Some sub-sovereign entities as well. Banks in many estimates show that the potential for such countries have used future remittances as col- bond financing remains untapped, especially lateral for raising significant bond financing in many poor countries that also receive (sometimes billions of dollars) from interna- significant remittances. The funds raised via tional markets. The interest spread on these these bonds can be targeted to specific bonds was lower and the tenor was higher than development projects.

Notes

Earlier versions of this policy brief were presented at the Second Plenary Meeting of the Leading Group on Solidarity Levies to Fund Development, Oslo, February 6-7, 2007; and the Brainstorming session on Migration and Development organized by the Migration Policy Institute and the German Marshall Fund of the , Brussels, February 27, 2007. It draws heavily on Ratha (2003) and Global Economic Prospects 2006: Economic Implications of Remittances and Migration. Thanks to Uri Dadush and Sanket Mohapatra for extensive discussions and Zhimei Xu for research assistance. The views expressed are the author’s own, not those of the World Bank. This paper will also appear in Migration, Trade, and Development: Proceedings of a Conference Sponsored by the Federal Reserve Bank of Dallas, The Tower Center for Political Studies, the Department of Economics at Southern Methodist University and the Jno E. Owens Foundation, October 2006. Reprinted by permission.

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References

De, Prabal K. and Dilip Ratha. 2006. Ratha, Dilip and William Shaw. 2007. “International Migration Behavior and South-South Migration and Remittances. Impact of Remittances on Human Capital: World Bank Working Paper No. 102, Evidence from Sri Lanka Integrated Washington, DC. Household Survey.” World Bank. Mimeo. World Bank. 2005. Global Economic Ratha, Dilip. 2003. “Worker Remittances: Prospects 2006: Economic Implications of An Important and Stable Source of External Remittances and Migration. Washington, DC. Development Finance.” Global Development Finance 2003. World Bank. For more references, please see World Bank (2005).

About the Author

Dilip Ratha is a Senior Economist and Manager of the Migration and Remittances Team in the Development Prospects Group at the World Bank. An expert on remittances and migration, he is the author of “Workers’ Remittances: An Important and Stable Source of External Development Finance” in Global Development Finance, 2003, and a lead author of the World Bank flagship publication, Global Economic Prospects 2006: Economic Implications of Remittances and Migration. He has written exten- sively on international finance topics including shadow-ratings for unrated countries, future-flow securitization as a tool for development financing, and the rise of South-South foreign direct investment. Prior to joining the World Bank, he worked as a regional economist for Asian emerging markets at Credit Agricole Indosuez, and as an Assistant Professor at the Indian Institute of Management, Ahmedabad. He has a PhD in economics from the Indian Statistical Institute, New Delhi.

15 MORE FROM MPI:

The Migration Policy Institute This policy brief is the third in a series from MPI’s Program on Migrants, Migration, and Development. Future reports in the series will include an analysis of the policy gap (MPI) is an independent, between migration and development strategies and the Overseas Workers’Welfare nonpartisan, nonprofit think Administration in the Philippines. Previous publications of the program include: tank dedicated to the study of • “The Phenomenal Rise in Remittances to India:A Closer Look” by Muzaffar A. Chisti, the movement of people May 2007. worldwide.The institute • “Circular Migration and Development:Trends, Policy Routes, and Ways Forward” by provides analysis, development, Dovelyn Rannveig Agunias and Kathleen Newland, April 2007. • Special Issue on Migration and Development. Migration Information Source. February and evaluation of migration 2007. Online at: http://www.migrationinformation.org/issue_feb07.cfm. and refugee policies at the • “Remittances and Development:Trends, Impacts, and Policy Options: A Review of the Literature” by Dovelyn Rannveig Agunias, September 2006. local, national, and international • “From Zero-Sum to a Win-Win Scenario: A Literature Review on Circular Migration” levels. It aims to meet the by Dovelyn Rannveig Agunias, September 2006. rising demand for pragmatic • “Beyond Remittances:The Role of Diaspora in Poverty Reduction in the Their Countries of Origin.” A Scoping Study by Kathleen Newland with Erin Patrick for the responses to the challenges Department of International Development, UK, July 2004. and opportunities that MPI’s work on Migrants, Migration, and Development can be accessed at migration presents in an ever http://www.migrationpolicy.org/research/migration_development.php and is made possible more integrated world. MPI by the generous support of the John D. and Catherine T. MacArthur Foundation, and by a produces the Migration grant from the Multilateral Investment Fund of the Inter-American Development Bank. Information Source at www.migrationpolicy.org

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