Remittance

What Is Remittance?

A remittance is a transfer of money by a foreign worker to an individual or family in their home country. This financial transaction falls under the broader category of international finance, representing a significant component of global cross-border payments. Remittances are typically sent by migrants to support their families, cover living expenses, invest in education, healthcare, or small businesses in their countries of origin. They differ from other international financial flows in that they are generally person-to-person transfers rather than institutional investments or aid.

History and Origin

The practice of sending money earned abroad back home is as old as migration itself. Historically, as people moved for work, they found ways to send funds to their families. In the 19th century, countries like Spain, Italy, and Ireland saw a significant portion of their national income derived from funds sent by their citizens living overseas, often through informal channels or by mail⁵².

The global landscape of remittances evolved significantly with improved transportation and communication, leading to more formalized channels. After the Great Famine of 1846–1848, for instance, the Irish diaspora supported rural communities back in Ireland through remittances. ⁵¹The recognition of remittances as a major force in global development finance gained prominence in the early 2000s. In 2002, official flows to developing countries reached an estimated $88 billion, with unofficial transfers potentially doubling that figure. ⁵⁰This growing awareness led to increased focus by international bodies on facilitating these flows and studying their impact, as highlighted in various academic literature.
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Key Takeaways

• Remittances are money transfers made by migrants to their home countries, serving as a vital source of household income for many families in developing economies.
• They often surpass other external financial flows, such as foreign direct investment and official development assistance, in low- and middle-income countries.
  *⁴⁵, ⁴⁶, ⁴⁷, ⁴⁸ Remittances can play a crucial role in poverty reduction and act as a safety net during economic downturns or crises in recipient countries.
  *⁴², ⁴³, ⁴⁴ While offering significant benefits, remittances also present challenges, including high transfer costs and potential macroeconomic impacts like currency appreciation.
• Efforts are ongoing by international organizations to reduce remittance costs and enhance their productive use through improved financial system infrastructure and policies.

Formula and Calculation

Remittance itself is a direct transfer of funds, so there isn't a complex formula to calculate the remittance amount itself from a sender's perspective beyond the amount sent minus fees. However, the economic impact of remittances on a recipient country's gross domestic product (GDP) can be considered.

The total value of remittances for a country is generally aggregated as:

Where:

• (\text{N}) represents the total number of individual remittance transactions.
• (\text{Amount Remitted}_i) is the gross amount sent in transaction (i).
• (\text{Fees}_i) are the costs associated with sending transaction (i).

For macroeconomic analysis, economists might look at the ratio of remittances to GDP to understand their significance to a national economy. For instance, in 2023, remittances accounted for 3% or more of GDP in over 60 countries.

⁴¹## Interpreting the Remittance

Remittances are interpreted as a significant and often stable source of external funding for recipient countries, particularly developing economies. Unlike other capital flows, remittances are generally countercyclical, meaning they tend to increase during times of economic hardship or natural disasters in the migrants' home countries, providing a crucial lifeline. ³⁹, ⁴⁰For individual households, remittance inflows can directly improve living standards by financing basic consumption, education, and healthcare. A³⁸t a national level, they can help stabilize the balance of payments and provide essential foreign exchange earnings.

³⁶, ³⁷## Hypothetical Example

Consider Maria, a migrant worker from the Philippines, who works in Canada. Each month, she sends C$500 to her family in Manila to support her parents and younger siblings. She uses a digital money transfer service.

1. Sending: Maria initiates a transfer of C$500.
2. Fees and Exchange Rate: The service charges a C$10 fee and converts the remaining C$490 into Philippine Pesos (PHP) using the prevailing exchange rate, say, 1 CAD = 40 PHP.
3. Calculation: C$490 * 40 PHP/CAD = 19,600 PHP.
4. Receipt: Maria's family in Manila receives 19,600 PHP.

This 19,600 PHP represents Maria's remittance for the month. For her family, this consistent inflow significantly boosts their monthly household income, enabling them to cover food, utilities, and school fees for her siblings.

Practical Applications

Remittances have widespread practical applications across various facets of finance and development:

• Poverty Alleviation and Consumption Smoothing: Remittances directly provide income to families, helping to reduce poverty and smooth consumption, especially in rural areas or during economic shocks.
  *³⁴, ³⁵ Investment in Human Capital: Funds are often used for education and healthcare, contributing to the development of human capital in recipient countries.
  *³², ³³ Macroeconomic Stability: Large and stable remittance flows can bolster a country's foreign exchange reserves, improve its current account balance, and enhance its creditworthiness, potentially attracting further investment.
  *³⁰, ³¹ Financial Inclusion: The infrastructure built for remittance transfers, including mobile money and agent networks, can extend financial inclusion to unbanked populations. The Federal Reserve, among other institutions, has noted the potential for faster, cheaper, more transparent, and more inclusive cross-border payment services to benefit economies worldwide.
  *²⁹ Disaster Relief and Crisis Support: Remittances often increase after natural disasters or economic crises, serving as an informal insurance mechanism for affected households and communities.

²⁸## Limitations and Criticisms

Despite their significant benefits, remittances are not without limitations and criticisms:

• High Transfer Costs: The cost of sending remittances remains a significant concern, especially for lower-value transfers to certain regions. The global average cost for sending $200 was 6.4% in the fourth quarter of 2023, more than double the Sustainable Development Goal target of 3%. T²⁷hese high fees reduce the actual amount received by families.
• Dependency and Labor Supply Effects: Some arguments suggest that large, sustained remittance flows could foster a culture of dependency, potentially reducing labor force participation in recipient countries. T²⁵, ²⁶here are also concerns that they might reduce incentives for governments to provide essential services or foster domestic economic growth.
  ²⁴* Macroeconomic Vulnerabilities: Substantial remittance inflows can lead to an appreciation of the real exchange rate, potentially harming the competitiveness of a country's export sectors. T²², ²³his is sometimes referred to as "Dutch Disease."
• Informal Channels and Illicit Flows: A significant portion of remittances still flows through informal channels, which are harder to track and regulate. While this can sometimes be more efficient for senders, it poses challenges for data collection and raises concerns about potential money laundering or financing of illicit activities. F²¹ederal Reserve officials have also noted that certain frictions in payment systems are purposefully built for compliance and risk management, suggesting caution in rapidly linking systems without addressing these concerns.
  *²⁰ Inflationary Pressures: In some cases, large inflows of remittances can contribute to inflationary pressure in the recipient economy, especially for non-tradable goods and services.

¹⁹## Remittance vs. Foreign Direct Investment

While both remittances and foreign direct investment (FDI) represent external financial inflows to a country, they differ significantly in their nature, drivers, and impact.

Remittances are often hailed for their direct impact on poverty reduction and household income, bypassing governmental or corporate intermediaries. In contrast, FDI focuses on productive capacity building and technology transfer. For many low- and middle-income countries, remittances have consistently outpaced FDI as a source of external finance.

¹⁴, ¹⁵, ¹⁶## FAQs

Q: Who sends and receives the most remittances?
A: High-income countries, particularly the United States, are consistently the largest source of remittances. I¹², ¹³ndia has been the largest recipient country for remittances since 2008, followed by countries like Mexico, China, and the Philippines.

⁹, ¹⁰, ¹¹Q: How are remittances typically sent?
A: Remittances can be sent through various channels, including traditional banks, specialized money transfer operators (MTOs), postal networks, and increasingly, digital platforms and mobile money services. Digital channels often offer lower costs and greater speed.

⁸Q: What is the economic impact of remittances on a country?
A: Remittances can have a profound economic impact, contributing significantly to a country's gross domestic product, reducing poverty, improving nutritional outcomes, and boosting investment in education and healthcare. T⁵, ⁶, ⁷hey also provide a stable source of foreign exchange.

Q: Are remittances always beneficial?
A: While largely beneficial, remittances can have potential drawbacks. These include high transfer fees, potential for inflationary pressure in recipient economies, and the risk of fostering dependency or disincentivizing labor market participation. T³, ⁴here are also concerns about funds being channeled informally, making them difficult to track.

Q: What efforts are being made to improve remittance flows?
A: International organizations like the World Bank and the International Monetary Fund, along with initiatives by entities like the Federal Reserve, are working to make remittances cheaper, faster, more transparent, and more inclusive. T¹, ²his includes advocating for lower fees, promoting digital payment solutions, and improving data collection and regulatory frameworks to reduce illicit flows.