Remittances in International Finance

Link to the Economist article “Like manna from heaven: How a torrent of money from workers abroad reshapes an economy”

The recycling of currency to its home currency area is crucial to understanding international finance and trade balances. As I laid out in “International Finance: A Primer,” unless someone abroad–outside the US dollar zone–intends to accumulate a pile of dollar-denominated assets, then once dollars are abroad, the only way those dollars can get back home is by being used to buy exports from the US. And imports in the US send dollars back abroad, so it is only net exports that can get them back home to stay. So sending unwanted dollars abroad inevitably leads to more net exports from the US, with US dollar exchange rates doing whatever it takes to make that happen. 

It is theoretically possible that changes in the exchange rate might change what people want to do with their investments. But it seems much likely to me that exchange rates mainly cause the adjustment of dollar flows from net exports to balance out other dollar flows, while exchange rate movements cause relatively little adjustment of capital flows or other dollar flows. 

That currency tends to make its way back to its home currency area–and any exception is treated as a capital flow–is often expressed through the equation NCO = NX: net capital outflows equal net exports. But remittances–relatives sending money home from their work abroad–and to a lesser extent foreign aid, cause currency flows as well. The graph at the top, from the very interesting Economist article “Like manna from heaven,” shows the importance of remittances. 

Consider currency flows in and out of India. One could track the flow of rupees, but an alternative is to track the flow of all other currencies in and out of India. Except when Indians want to accumulate or decumulate piles of foreign-currency-denominated assets, foreign currency that comes in will go out to buy foreign goods as imports–or actually as net imports if some round trips from balanced bits of trade are ignored. For this, it doesn’t matter how the foreign currency comes in (unless it is from intentional selling foreign assets, which we are leaving aside). Whether the dollars or other foreign currency arrives from foreign direct investment in India (minus FDI going out of India), foreign portfolio investment (minus intentional portfolio investment going out of India), remittances or foreign aid, those dollars or other foreign currency will make their way back out buying net imports.  

Don’t assume that raising net imports is a bad thing. As “Like manna from heaven” indicates, the resources from remittances in particular allow many families to have nicer houses, buy more refrigerators and other appliances, and give them enough financial leeway that they are willing to let their daughters stay in school longer. Most of the money from abroad is spent on things that I personally applaud.