Remittance is a method of international settlement and payment where the remitter sends funds to the recipient with the assistance of financial institutions like banks. In this process, financial institutions typically charge an additional fee.
In the context of globalization, remittance usually refers to people living or working abroad sending a portion of their income to relatives in their home country, or sending goods back to support their families. Therefore, this method of remittance is also known as migrant remittance.
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The Scale of Remittance Worldwide
In recent years, the scale of global remittances has been growing rapidly. Currently, for many developing countries, remittances are their primary source of foreign exchange income.
Accurately estimating the scale of remittances is not easy, as many transfers are made through informal channels in addition to official records. According to data from the World Bank, the total officially recorded international migrant remittances reached $860 billion in 2023, with $669 billion flowing to low- and middle-income countries. These are only the officially recorded figures, and the World Bank estimates that unrecorded fund flows through informal channels are at least 50% larger than the official data.
Remittances are not only large in scale but are also more evenly distributed among developing countries compared to capital flows, including foreign direct investment.
Remittances play a crucial role in regional economic development, especially for low-income countries. Overall, remittances account for nearly 4% of the GDP in low-income countries, while in middle-income countries, they account for about 1.5% of GDP.
How Remittance Works
A typical remittance transaction involves three steps:
- The overseas remitter pays funds to an agent in the form of cash, check, money order, credit card, debit card, or a debit instruction sent via email, telephone, or the internet.
- The remittance agent instructs an agent in the recipient’s country to deliver the remittance.
- The paying agent delivers the funds to the recipient.
In most cases, funds are not transferred between agents in real-time but are settled periodically through commercial banks. Some informal remittances may also be settled through trade in goods.
The cost of a remittance transaction includes the fee charged by the remittance agent and the currency conversion fee incurred when delivering local currency to a recipient in another country, which is usually paid by the remitter. Some smaller agents may charge the recipient an additional fee to hedge against unexpected exchange rate fluctuations.
It is important to note that large agents, especially banks, may invest the funds before delivering them to the recipient, thereby earning interest or indirectly profiting from interest rate floats. In countries with high overnight interest rates, the gains from interest rate floats can be substantial.
Remittances are typically transfers between different individuals or families. International remittances usually flow from high-income countries to low- and middle-income countries, thus helping to reduce poverty. For example, Nepal’s poverty rate decreased by 11% during its political conflict from 1995 to 2004, with about one-fifth to one-half of this reduction attributed to remittances.
In relatively poor households, remittances are often used to purchase basic consumer goods, housing, and for children’s education and healthcare. In relatively wealthier households, remittances may be used to finance small businesses or entrepreneurial activities. Additionally, in some countries, national banks use future remittances as collateral to lower international borrowing costs.
The Relationship Between Remittance and the Economic Environment
Remittance flows are generally more stable than capital flows, and their trends are often counter-cyclical. After economic recessions or natural disasters, remittance flows typically increase, while private capital flows tend to decrease. In countries affected by political conflict, remittances are often a vital economic lifeline for the local poor. According to the latest data from the World Bank, Tajikistan, the poorest country in Central Asia, has the highest ratio of remittances to GDP globally, at about 51%.
In remittance-source countries like the United States and Western European nations, migrant incomes were affected by the economic environment during financial crises, but they still tried to compensate for income loss by cutting consumption and rent expenses. Workers in sectors heavily impacted by financial crises moved to other industries. The financial crisis reduced new migration flows but also discouraged old migrants from returning home due to the risk of not being able to re-enter the host country. For these combined reasons, the number of migrants and the amount of remittances did not decrease even during the global financial crisis.
Remittances also come with potential costs. The emigration of both high-skilled talent and general labor can create a risk of labor shortages in the home country, leading to increased costs for economic activities. Furthermore, if the amount of remittances is large, the receiving country may face a real exchange rate appreciation, leading to a decline in international competitiveness.
The amount of remittances received and local economic growth often show a negative correlation. This could be because long-term reliance on overseas remittances may reduce the work incentive of recipients, thereby slowing local economic growth. However, it could also be that migrants working abroad are more likely to send more money home to their families during times of economic recession.
How Much Does Remittance Cost
Remittances involve transaction costs. These costs vary by amount, typically using a tiered-rate system based on the remittance amount, with a cap. In general, transaction costs for large remittances (for trade, investment, or aid) are very low, as they are negligible compared to the remittance amount. Large international banks favor large remittances. However, for small remittances, transaction costs are a significant factor to consider.
Data from the World Bank shows that as of the second quarter of 2023, the transaction cost for every $200 remitted was 6.2%. Bank transfers are the most used method but also have the highest transaction costs, averaging 12%. In contrast, newer mobile-based tools that have emerged in recent years have the lowest transaction costs at just 4.1%, but currently, this channel accounts for less than 1% of the remittance market.
Besides the economic costs, the human costs of remittance should not be overlooked. Migrants give up the opportunity to live with their families and bear the risks of finding a job in another country. In a foreign land, they may have to work very hard to save enough money to send home to their families.
Remittance-Related Policies
Some countries offer incentives to increase remittance flows and channel them into productive uses like investment. However, implementing such policies can be problematic. In comparison, promoting financial services or reducing transaction costs may be more feasible. Tax incentives might attract remittances but could also encourage tax evasion.
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