Remittances Work for Africa Sanjeev Gupta, Catherine Pattillo, and Smita Wagh

Making Remittances Work for Africa Sanjeev Gupta, Catherine Pattillo, and Smita Wagh

If handled EMITTANCES flowing into devel- are met. By contrast, study of the impact of oping countries are attracting in- remittances at the aggregate level is confined well, migrant creasing attention because of their mostly to Latin America and South Asia, transfers can rising volume and their impact where remittance volumes swamp those going Ron recipient countries. In 2005, they totaled to SSA. This article adds some insights about reduce poverty $188 billion—twice the amount of official as- the role of remittances in SSA and offers sug- and connect sistance developing countries received. More- gestions for their more effective use. over, there is evidence that such flows are small savers underreported. Indeed, remittances through A snapshot of remittances to the formal informal channels could add at least 50 percent Africa receives just 4 percent of total to global recorded flows. Most of the reported remittances—by far the smallest share—to financial flows go to regions other than sub-Saharan developing countries and just 33 percent of sector Africa (SSA), but SSA has still been part of those to India, the top recipient. In contrast, the overall rising global trend. Between 2000 countries in Latin America and the Caribbean and 2005, remittances to the region increased receive about 25 percent of all remittances, by more than 55 percent, to nearly $7 billion, as do countries in the East Asia and Pacific whereas they increased for developing coun- region. Since the 1980s, these flows to countries as a group by 81 percent. tries in Latin America and the Caribbean, and Studies relying on household data from East Asia and the Pacific have grown more different countries in SSA yield some insights rapidly than the average for developing coun- into how remittances are used. At their core, tries. In 2005, the top three recipients—China, remittances are private intrafamily or intra- India, and Mexico—accounted for more than community income transfers that directly one-third of the remittances to developing address the single most relevant challenge countries. Among the top 25 recipients, only for SSA countries: poverty. Their long-term one (Nigeria) was in Africa, but three South development potential is determined by what Asian countries were on the list (Bangladesh, is left over after basic consumption needs India, and Pakistan).

40 Finance & Development June 2007 ©International Monetary Fund. Not for Redistribution Relative to GDP, too, the volume of remittances to SSA is Development (OECD). By one estimate, almost one-fourth of smaller than to other developing countries: about 2.5 percent of the new overseas-trained physicians that registered with the GDP on average between 2000 and 2005 compared with almost U.K. National Health Service between 2002 and 2003 came 5 percent for other developing countries. But Lesotho, Cape from SSA. About 80 percent of nurses from Liberia and an Verde, Guinea-Bissau, and Senegal are striking exceptions (see equal number of doctors from Mozambique are working in Chart 1), and, in some countries, remittances are an important industrial countries. High job vacancy or attrition rates in the source of foreign exchange. public health systems of countries like Ghana, Zambia, and Remittances sent to SSA through informal channels, at Zimbabwe are all attributed to migration. On average, 20 per- 45–65 percent of formal flows, are significantly higher than in cent of SSA’s population over the age of 15 with a postsecond- other regions. In addition, the balance of payments very likely ary education works in OECD countries compared with less underreports intraregional remittances. Intraregional migra- than 10 percent in South Asia. For some countries, expatria- tion is common in SSA; for example, Botswana and South tion rates exceed 50 percent of the educated population. Africa attract migrant workers from neighboring countries, Some analysts, however, contend that the possibility of and strong sociocultural ties in West Africa encourage labor higher wages abroad has, in fact, increased the region’s sup- mobility in that subregion. ply of health care professionals, even after accounting for How do remittances stack up against other flows to SSA? emigration. Although the explicit costs of the migration of Both official development assistance (ODA) and foreign skilled workers are still being debated, they provide a useful Making direct investment (FDI) are considerably higher than remit- context in which to evaluate the benefits of remittances. tance receipts but are also more volatile (see Chart 2). The stability of remittances suggests that, through the securitiza- Impact of remittances tion of future flows, they can potentially ease access to, and How are remittances affecting Africa as a whole? We begin Remittances lower borrowing costs for, international capital. Some stud- by looking at their impact on poverty. Remittances augment ies have concluded that because remittances are widely dis- recipient households’ resources, smooth consumption, provide persed, their Dutch disease effects are relatively contained. working capital, and have multiplier effects through increased However, as with any form of external flows, remittances do household spending. Evidence from Ghana indicates that Work for carry the risk of real exchange rate appreciation and could remittances are countercyclical and, over time, help smooth Africa hurt export competitiveness in the recipient country— household consumption and welfare, especially for food crop something policymakers must be prepared for. farmers, who are typically the most disadvantaged socio- Remittances, especially those from skilled migrant work- economic group. For the most part, remittances are used to ers,Author have: beenGupta associated with brain drain, a cause for concern finance consumption or invest in education, health care, and inDate: the region. 5/14/07 Some analysts attribute the crisis in SSA’s health nutrition. Studies from a cross-section of developing countries sectorVersion: to 3 the emigration of skilled health care profession- tend to confirm the findings of these localized surveys. als, who increasingly find employment in the high-demand The relationship between remittances and poverty is not countries of the Organization for Economic Cooperation and unidirectional. Poverty and the accompanying lack of eco-

nomic opportunities play a role in motivating emigration and incoming remittances. Villages in Senegal sometimes Chart 1 pool resources to pay for the migration expenses of their Top African destinations most skilled young men. Remittances are the return on this Lesotho and Cape Verde receive the largest remittance flows jointAuthor investment.: Gupta Poorer households with migrant worker relative to their size. membersDate: 5/3/0 are also7 more likely to get a steady income supple- (ratio to GDP, percent) ment from abroad—another reason that higher poverty Lesotho Version: 5 Cape Verde might mean more remittances. Guinea-Bissau Senegal Togo Uganda Comoros Chart 2 Swaziland Mauritius Lower but steadier Kenya 0 5 10 15 20 25 30 Remittances are not as high as other flows but are less volatile. (ratio to export earnings, percent) (inflows to SSA; million dollars, 1975−2004) Lesotho 25,000 Cape Verde Uganda 20,000 Comoros Aid Senegal 15,000 Guinea-Bissau 10,000 Benin Direct investment Togo 5,000 Burkina Faso Remittances Kenya 0 0 10 20 30 40 50 60 –5,000 1975 80 85 90 95 2000 04 Sources: IMF, Balance of Payments Yearbook (2006); IMF, World Economic Outlook database (2006); and World Bank staff estimates. Sources: IMF, Balance of Payments Yearbook (2006); IMF African Department database Note: Rankings are based on average remittance inflows for 2000−05. (2006); and OECD Development Assistance Committee database (2006).

Finance & Development June 2007 41 ©International Monetary Fund. Not for Redistribution Our empirical analysis—using data from 233 pov- Informal money transfer systems modeled on the hawala erty surveys in 76 developing countries, including 24 in system in the Middle East dominate the remittance market SSA—confirms the poverty-reducing effect of remittances: a in several African countries. Informal providers offer such 10 percent rise in the remittances-to-GDP ratio is associated client-friendly features as anonymity, minimal paperwork, with a fall of a little more than 1 percent in the percentage and speed. But the lack of supervision of these markets makes of people living on less than $1 a day and the poverty gap it a risky proposition for the recipients of small remittances (which measures how far below the poverty line the average to continue to rely on these channels. poor person’s income is). Further, we find that even taking The cost of formally transferring funds to SSA, especially into account the impact of poverty on remittances, in a model small sums, is high. A survey of U.K. money transfer opera- in which both poverty and remittances are simultaneously tors (MTOs) found that the fee on money transfers was lower and endogenously determined, the poverty-reducing effect between the United Kingdom and India, where volume is high, of remittances remains. However, the average remittance- than between the United Kingdom and Africa (see Chart 3). inducing effect is slightly greater. The market in money transfers between SSA countries is espe- How about the impact of remittances on long-term growth cially underserved by formal institutions, and the prohibitive potential? The direct impact depends on how households use fees they charge severely depress their use. A study in South the remittances, how migration affects the domestic labor Africa found that the comparative cost of an international supply and output, how recipient households respond to this transfer of 250 rand was the lowest when it went through a steady transfer, and whether remittances promote financial friend or a taxi driver and the highest when it went through a deepening. Studies that focus on the labor supply response bank. Although cross-border post office transfers are competi- of recipient households find that remittances lower growth. tively priced, they are slower and less secure. But studies that link remittances to the investment channel, The underdeveloped financial infrastructure is another whereby remittances either substitute for or improve financial deterrent. The absence in South Africa of a major MTO like access, tend to conclude that remittances stimulate growth. Western Union further limits competition among the play- We looked at an indirect consequence of cross-border ers in the formal market and increases the likelihood that money transfers: their impact on financial development. migrant workers will use informal channels to send money Because migrant transfers entail cross-border flows of rela- home. Since September 11, 2001, scrutiny of international tively modest sums of money, they enable low-income house- money transfers has increased, and many banks are imposing holds to access formal financial services, starting, most likely, more identification requirements on both individuals and with savings products. But the growing interest of micro- small MTOs. In South Africa, only authorized dealers, who finance institutions in this segment of the market raises the must have a banking license and have invested in an expen- possibility of remittances serving as collateral for small busi- sive exchange control reporting system, can remit funds. By ness start-up capital for individuals previously excluded from further increasing the effective cost, the rules discourage the formal sector. For SSA in particular, a lack of access to remittances through formal channels. Although these costs formal financial services impedes financial deepening. are unavoidable for preventing money laundering and ter- We investigated the impact of remittances on financial rorist financing, there is some leeway in the extent to which development in 44 African countries over six time periods, they are passed on to clients. composed of five-year averages from 1975 to 2004. Our find- AuthorMoreover,: Gupta given excess liquidity in most SSA banks, there ings confirm that remittances promote financial deepening in isDate: little interest5/3/0 7in the small remittances market. Most analysts the region, after controlling for macroeconomic and institu- see significant, untapped opportunities for banks to reduce Version: 2 tional variables that are commonly used to explain financial development in low-income countries. These results hold even after accounting for the possibility that reported remittances Chart 3 are likely to be higher in better-developed financial markets. Prohibitive fees Although SSA receives only a small portion of the remittances going to developing countries, their estimated effect on finan- Because of high fees on money transfers from the United cial development in our study compares favorably with other Kingdom, migrants prefer informal channels to Western Union. studies that use a larger sample of developing countries. (percent of transfer) 16 14 Ghana Making formal money transfers affordable 12 Kenya Nigeria India Although remittances can facilitate the entry of households 10 8 into formal financial markets, only a fraction of them find 6 their way into the formal system. The high fees formal pro- 4 2 viders charge deter poor migrants, who want to send small 0 sums of money home. Even if a migrant has access to banks, £100 £500 the recipient may not. As a result, many migrants rely more Source: United Kingdom, Department for International Development (2006). Note: Fees can change as a result of exchange rate changes, so the numbers should be on import-export operators, retail shops, and currency interpreted as indicative rather than precise. dealers, which do not keep records of their transactions.

42 Finance & Development June 2007 ©International Monetary Fund. Not for Redistribution the transaction costs on remittances, especially small remit- Getting more out of remittances tances sent by poor migrants. Financial sector reforms that Bringing recipient households into the formal financial sec- address any or all of the structural problems in the recipi- tor is only the first step in using remittances more effectively. ent and sending countries are also likely to lower the cost of Country surveys indicate that, although households typically remittances. In Uganda, measures permitting residents to spend a large proportion of their remittances, their propen- open foreign currency accounts led to a dramatic surge in sity to save can be as high as 40 percent. For policymakers, the private transfers in the early 1990s. Cross-border uniformity challenge is to channel these savings into productive uses. in the regulations related to remittances and regulatory inter- Most studies indicate that a large proportion of remit- ventions where fees are prohibitive have been proposed as tances is used for human capital development, whose other cost-reducing measures. long-term benefits are apparent, or consumption. The con- The growing demand for remittance services in well- struction of large houses for migrant workers in West Africa developed financial markets like the United States has has spurred local economic activity through multiplier captured the attention of major commercial banks, such effects. In Mexico, the Sociedad Hipotecaria Federal, a gov- as Citizens Bank and Wells Fargo. These banks see remit- ernment financial institution, provides long-term financing tance services as a way to draw the attention of a significant and partial mortgage insurance to Mexican mortgage pro- unbanked population to their more mainstream financial viders that extend peso-denominated loans to emigrants for products. In an arrangement with two banks in Cape Verde, housing construction in Mexico. The scheme simultaneously Citizens Bank offers Cape Verdean migrants a remittance encourages remittances and their productive use. Because of facility that is less expensive than Western Union. In three Africa’s inadequate financial infrastructure, similar schemes years of operation, this program has made more than 1,000 can be more challenging to launch there, but they can spur a formerly unbanked migrants customers of Citizens Bank. sustained housing boom with positive spillovers on the real However, most such programs require that the migrant open and financial sectors of the economy. a bank account and are thus unlikely to appeal to undocu- SSA banks can promote investment from remittances by mented workers. bundling financial services like savings products and entre- Among formal providers, it is the smaller banks and micro- preneurial loans for households that receive remittances. finance institutions that have gauged the untapped potential The market is currently dominated by specialized MTOs like of this market. Microfinance institutions are well suited to Western Union that are less likely to offer their clients ancil- meet the needs of the typical remittance-receiving house- lary financial products. Banks could also consider using the hold. At the same time, these institutions view remittances as flow of remittances as collateral for small business loans. a timely capital infusion to overcome the operational prob- The bottom line is that remittances cannot be a substitute lems that currently plague the sector. In countries with a long for a sustained, domestically engineered development effort. history of migration, some small banks have adapted to the Moreover, large-scale migration may hurt domestic labor needs of the migrant community. For instance, Theba Bank, markets in specific sectors, particularly when those leaving are a miners’ bank, offers low-cost transfers from South Africa mostly skilled workers. High and rising remittance flows also to families that have bank accounts in Mozambique and require policymakers to remain alert to possible Dutch disease Swaziland. The International Remittance Network—about effects on the real exchange rate. Nevertheless, migrant trans- 200 credit unions that offer low-cost remittance services in 40 fers can help ease the immediate budget constraints of recipi- countries in Asia, Africa, Europe, and Latin America—does ent households. For developing countries as a whole, they are a not require that the recipient family have an account. larger transfer of resources than all development assistance and New technologies are also lowering the cost of transfer- have a more direct impact on poverty. And the vast, untapped ring funds. Recent strides in cell phone encryption technol- market in money transfers is an opportunity for small savers to ogy have facilitated fast, low-cost money transfers between gain a foothold in the formal financial sector. n OECD countries and recipient countries as diverse as the Philippines and Zambia, allowing customers to avoid the Sanjeev Gupta is a Senior Advisor in the IMF’s Fiscal Affairs higher fees and longer waiting periods associated with Department, and Catherine Pattillo is a Senior Economist in MTOs and banks. Recently, telephone operators with net- the African Department, where Smita Wagh is a Project Officer. works in more than 100 countries announced that they would allow clients to send money home simply as text This article is based on IMF Working Paper No. 07/38, “Impact of messages. If households at the receiving end do not have a Remittances on Poverty and Financial Development in Sub-Saharan bank account, the remitted sum can be converted to a pre- Africa.” Please see that paper for details on the empirical methodology, paid debit card that can be used directly to make purchases. a list of references to the literature on this topic, and the primary sources Financial institutions can make these technological inno- from which some of the material in this article is drawn. vations work to their advantage most effectively in areas in which retail banking networks are weakest. Recently, Reference: South Africa’s First Rand Bank bought Celpay, a cell phone Clemens, Michael, 2007, “Do Visas Kill? Health Effects of African banking service provider operating in Zambia and the Health Professional Emigration,” CGD Working Paper No. 114 Democratic Republic of the Congo. (Washington: Center for Global Development).