What Are the Effects of Currency Volatility on Remittances
Fluctuations in foreign exchange rates can affect the number of remittances transferred to another part of a different country. While any payment of a bill or an invoice can be a remittance, the term is mainly used nowadays to refer to the money sent overseas.
If you live or work abroad and want to send some money to your family back home, it’s imperative to consider the currency exchange rates. It will affect the amount of money to send or receive. This guide looks at the impacts of currency volatility on remittances.
Understanding the Effects of Remittances on Economies
According to a report from the World Bank, remittances are currently the second largest resource inflow in many developing countries after foreign direct investment (FDI).
Notably, remittances have stabilized the inflow of foreign currency in some developing economies. They are now a more significant source of foreign exchange than portfolio investment flows and foreign direct investments in the countries.
The impacts of remittances on the volatility of exchange rates play a significant role in a country’s financial development. Partially dollarized countries have greater exchange rates and inflation volatility due to the inflow of remitted funds.
Countries with highly dollarized economies and consistent inflow of remittances need to consider the effect of the remittances on currency markets.
Here some of the ways remittances can affect the economy of a country.
External Equilibrium of an Economy
Remittances can affect the external equilibrium of an economy by raising a country’s net foreign asset position. Since remittances are transfers of foreign currencies, unlike other forms of international flows, they directly impact the country’s financial position.
Note that the impact of remittances on the stock of net foreign assets is different from that of other flows like loans and foreign direct investment flows.
In the case of loans, a country is obligated to repay the funds. So, the contribution to the country’s net foreign asset position is the difference between the net present value of the repayment obligation and the proceeds. For that reason, loans can positively affect a country’s net foreign assets to the extent they bring a positive grant component.
When it comes to FDI (foreign direct investments), the investments flowing into the recipient country will raise the foreign liabilities. Consequently, the net foreign asset position of the country will decline.
Internal Equilibrium of an Economy
Remittances can also impact the internal equilibrium of an economy when the domestic labour and capital are utilized efficiently.
If the remittances accelerate the demand for services, inflation rates tend to be higher in the sectors, which are generally not tradable. They are protected from competition, resulting in exchange rate appreciation, a traditional Balassa-Samuelson effect.
Effect on Economic Growth
A third way remittances can impact the real exchange rate is how they influence growth, although the impact is not likely to be certain.
On the one hand, the acceleration in the growth rate would reduce the real exchange rate. The growth would bring the same impact as the increase in a country’s liabilities.
On the other hand, the country’s net foreign asset position would be harmful relative to the different parts of the world. The increased growth rate would reduce the liabilities to the GDP ratio. Consequently, the exchange rate would appreciate.
Impacts of Currency Volatility on Remittances
Now that you know how remittance can affect the performance of a country’s economy, it’s also essential to understand how currency volatility can impact remittances.
Remittances can help to mitigate exchange rate volatility resulting from an outflow. That is because of their indirect stabilizing effect on exchange rate volatility when other types of capital flows fluctuate drastically. They offer regular sources of foreign currency into the dollarized economies.
Since an economy with a high degree of partial dollarization is more sensitive to the changes in foreign currency inflows, remittances can negate part of the impact on the exchange rate volatility. The supplemental source of foreign currencies can mitigate the level of short-term exchange rate movements.
How the Currency Volatility Does Affects Remittances
When remitting, remitters must always take into account the domestic currency’s value. That is why the currency exchange rates matter a lot when it comes to remittances.
If the domestic currency appreciates, the remittances ratio will reduce as it will present a form of cost to the remitter.
Even so, remittances may increase following the appreciation of the domestic currency, mainly when the remitter targets a particular and stable amount of money.
For that reason, you can note that remittances expressed in the sending country’s currency will increase with the appreciation of the receiving country’s currency.
Any depreciation of a currency is profitable in inward remittances. An excellent example is India, where the depreciation of the Indian rupee usually has a positive effect on remittances. Remittances are among the main contributors to the country’s foreign exchange reserve.
In recent years, the country has recorded 50-80 percent growth in remittance inflow from several countries, especially in the Gulf areas.
Issues Facing Remittances
Besides the effects of currency volatility on remittances, there are concerns about the high costs of remittances to the senders. While some nations limit remittances to bank wires, they are among the most costly transfer channels for remitting funds.
According to the World Bank, banks charged an average of 11 percent in transfer fees, while post offices charged more than 7 percent on average. The costs can even be more than 10 percent when the funds’ destination is a Pacific Ocean Island or Africa.
The good news is that banks are not the only option to remit funds to your loved ones at home. You can rely on KnightsbridgeFX to help you transfer your money at the lowest currency exchange rates and fees. You can contact us to get a quote.
The impacts of currency volatility on remittances can significantly influence the amount of money the recipient will receive. However, countries rarely publicize the methods they use to record the funds people receive via remittances. Notably, most transfers are usually through the web or wire, where the authorities can quickly track them.