As outlined above, remittances are an important source of capital flows in most countries in South and South-West Asia, and help stabilize the macroeconomic situation. Indeed, in several countries in South Asia, remittances have been instrumental in keeping current account deficits under control in spite of a chronically negative trade balance. Research supports that remittances have the potential to be a balance-of-payments stabilizer (Bugamelli and Paterno 2005). This has especially been the case in Bangladesh and Nepal. Research also suggests that remittances can increase debt sustainability by reducing country risk. Moreover, in addition to increasing household and government income, they also boost the government’s revenue base and reduce the marginal cost of raising revenues (Chami and others 2008).
However, research on Sri Lanka indicates that the potential of remittances to buffer adverse macroeconomic shocks is rather limited. Remittances to the country tended to increase as the economic situation improved and declined during times of economic crises, which were often correlated with a deteriorating political situation. Remittances also climbed in tandem with rising oil prices, which can be attributed to increased job opportunities in the main destination countries, predominately oil-producing countries (Lueth and Ruiz-Arranz 2008).
Notably, much research has been conducted on the positive contribution of remittances to household income and poverty reduction but until recently, only a limited amount has been completed on the potential negative macroeconomic impacts of remittances.
Research on different countries of origin of migrants worldwide found the following negative macroeconomic impacts:
- Reduced fiscal discipline: Remittances may reduce governments’ incentive to maintain fiscal discipline. Empirical evidence suggests that governments may take advantage of the fiscal space afforded by remittances by consuming and borrowing more (Chami and others 2008).
- Dutch-disease effects (decreasing competitiveness of tradable goods due to exchange rate appreciation): Although remittances constitute a source of financing in the balance of payments, empirical evidence suggests that remittances are positively correlated with real exchange rate appreciation. Some evidence of Dutch-disease-effects, such as an increase in the prices of non-tradable goods in remittance-receiving countries has been shown. Also, evidence suggests that Dutch–disease effects are stronger in fixed exchange rate regimes (Lartey and others 2009).
- Reducing political will for policy reform: Remittances can pose a moral hazard problem by reducing the political will to enact policy reform. Compensatory remittances insure the public against adverse economic shocks and reduce households’ incentives to impress upon the government to implement reforms to facilitate policies for pro-poor economic growth (Chami and others 2008).
- Weaker institutions: Remittances are also associated with a weaker institutional environment. Regressions have shown that higher remittance receipts are associated with less control of corruption, lower quality of government and lower rule of law indicators. This may be linked to the moral hazard problem of reducing political well or pressure to enact governance reforms (Abdih and others 2008).
- Thus far, there is no proof that remittances have a positive impact on economic growth. It is even argued that remittances may delay growth-enhancing policies, reduce labour force participation and lead to riskier investments (Chami and others 2009).
- However, a significant drop in remittances would severely affect countries that are highly dependent on these inflows to sustain their economies. Research indicates that a slowdown or drop in remittances would likely increase the volatility of GDP output of the country and have adverse effects on its overall welfare (Chami and others 2009).