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What determine worker's remittances?

The main reason behind the significant decline in remittances is the large difference between the open market rate and government fixed rate of foreign exchange

By Abdul Waheed & Nooreen Mujahid Khalid
Feb 05 - 11,2001

Remittances are basically foreign exchange which is remitted by the people who are living abroad to their own countries. The different channels through which remittances are sent includes commercial banks, the hundi market, direct imports of consumer goods on visits home or through family and friends and through other informal channels. In general, there are two reasons for remitting money home: for the purpose of consumption by dependents and for savings in parent country. Remittances may take four types: (a) Potential Remittances; are the savings available to the migrant ones all his expenses are met in the host country.(b) Fixed Remittances; are the minimum amount a migrant sent to satisfy his family's basic needs. (c) Discretionary Remittances; are what the workers remittance over and above the fixed amount sent either through official or unofficial channels. (d) Saved Remittances: are retained savings are the amount not remitted. The worker can accumulate and remit them at any time.

The simplest form of Hundi market transactions consist of a Pakistani worker paying X amount of dollars and address of his dependents to an agent in the host country. The agent records the transactions in a register and gives the worker a receipt. The hundi Company then contacts its agent in the town closest to the address provided, who then makes arrangements for the delivery of money in rupees, converted at the predetermined hundi rate of exchange.

There are several reasons for the popularity of the Hundi market. First, the hundi rates of exchange are almost always higher than the official exchange rates used by the nationalized banks for converting remittances into rupees. Second, it may be argued that the hundi market transaction under taking through informal channels, and with a unregistered company and agent inherently involved greater risk than transaction carried out by official banks. This perception of the hundi market transaction riskiness may hold with some people, specially the professionals etc. However, most of the people believed that though only market is informal in nature but operates on the basis of trust and it is not the interest of the agent to acquire a bad reputation. Third, the key reason for the success of hundi market is the relative efficiency of the hundi system over the commercial banks. These include easier access, convenient timings, faster service and home delivery service.

Whether the worker sent remittances through the official or the unofficial market will depend on the difference between the official exchange rate and the black market rate as well as the cost of going through the unofficial market. The worker has no incentive to send his money through official channels if the difference between the official and parallel (black-market) exchange rate is greater than the cost of going to the parallel market. The flow of discretionary remittances is determined by the difference between the real domestic interest rate and the real foreign interest rate. For the worker to remit part of his savings over and above the fixed amount depends that the real interest rate in his home country must be greater than the interest rate in the host country or any other market accessible to the worker. If either one of these two conditions is not met, remittances will not be sent through official channels. In that case these remittances either will be sent through the unofficial market or they will remain in the host country as saved remittances.

During 1970s and 1980s, Pakistan has experienced a massive outflow of Pakistanis migrating to work in other countries particularly in the Middle East. This has resulted in a significant financial inflow in the form of remittances. The remittances have become a valuable source of foreign exchange for economic development of Pakistan. It had resolved in improving the balance of payments problem of the country. This migration had also helped in reducing the unemployment and underemployment in Pakistan. It has also resulted in improvement in the standard of living of the people.

However, the inflow of remittances has increased the demand for consumer goods, luxury items and led to inflation in the economy. It has also been experienced that in Pakistan, the significant portion of remittances was spent on unproductive investments such as real estate and housing. Generally, almost everyone results the inflation in the remittances recipient country.

Worker's Remittances (US $ Million)

Year

Remittances

% Change

Year

Remittances

% Change

1972-73

132.00

 

1987-88

2012.60

-11.67

1973-74

139.14

5.41

1988-89

1896.99

-5.74

1974-75

211.10

51.72

1989-90

1942.35

2.39

1975-76

339.20

60.68

1990-91

1848.29

-4.84

1976-77

577.72

70.32

1991-92

1467.48

-20.60

1977-78

1156.33

100.15

1992-93

1562.24

6.46

1978-79

1397.93

20.89

1993-94

1445.56

-7.47

1979-80

1744.14

24.77

1994-95

1866.10

29.09

1980-81

2115.88

21.31

1995-96

1416.17

-24.11

1981-82

2224.89

5.15

1996-97

1409.47

-0.47

1982-83

2885.67

29.70

1997-98

1489.55

5.68

1983-84

2737.44

-5.14

1998-99

1060.19

-28.82

1984-85

2445.92

-10.65

Jul-Mar98-99

806.98

 

1985-86

2595.31

6.11

Jul-Mar99-00

731.45

9.35

1986-87

2278.56

-12.20

     

Source: Economic Survey 1999-2000, Government of Pakistan, Economic Advisers Wings, Finance Division, Islamabad, (www.finance.govt.pk)

From the table, it is clear that in 1972-73, the workers remittances were about $136 million or 18% of the total merchandise exports and they increased every year. Within a decade, they reached as high as $2886 million surpassing the merchandized exports earnings by 10%.

Since then a declining trend in the remittances started and during 1988-89 it reached at $1896.9 million. The share of Middle East in total remittances fell from 85% in 1983-84 to 68% in 1988-89.

This decreasing trend continued in 1990's. The inflow of worker's remittance has been widely fluctuating $1848.3 million in 1990-91 $1409.5 million in 1996-97. In 1997-98 the remittances rose to $1489.5 million or by 5.7%.

Worker's remittances during July-April 1999-2000 amounted to $731.41 millions as against $806.98 million in the comparable period of 1998-99, indicating a decline of 30.9%.

The main reason behind the significant decline in remittances is the large difference between the open market rate and government fixed rate of foreign exchange. This large difference has discouraged expatriate Pakistani to send their remittances through official channels.

If we take a look at the statistics, there is a steep decline in the year 1997-98 to 1998-99. The reason is that after nuclear explosions the foreign currency accounts were seized and uncertain economic condition the people prefer to send their money through 'hundi' instead of official.

If, in future the amount of remittances continues to fall, other things remaining the same, not only will the GNP growth be lower than that of the GDP but it will also be difficult to maintain a high rate of growth. The foreign exchange which has been made available because of the workers remittances has not only helped in reducing the current account deficit, but has also reduced the external debt burden, and has improved debt- servicing ability, and has decreased the need for additional foreign loans. With the slowing down of the economic activity, Pakistan is likely to face balance of payments problems not only because of the reduced amount of remittances but also because of the decline in the demand for its exports.

There is a need of redirecting remittances from unofficial to official channels and the following prescription can be designed for that purpose.

a. Opening of Pakistani commercial bank branches in major labor importing countries

b. The use of mobile banking service in the Middle East economies

c. Increasing the speed of transactions of commercial banks by reducing the rules and regulations related to remittances.

d. Encouraging Pakistani migrants to open bank accounts in Pakistan prior to their departure abroad.

e. There's a need that Pakistan should explore new market for manpower export and maximize the benefits of migrant labor through efficient enabling of productive investment of these remittances into the economy.

f. The government should ensure economic stability and political stability. The government should also focus on reducing dependence on imports and encourage the domestic producers to meet the competition in local and international market so as to boost exports for foreign exchange inflow.