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Economic Research: Why Remittances Matter And Where Do They Matter The Most?

Worker remittances play an important role in most emerging and frontier economies that receive them. Among the major emerging markets (EM) that we cover (excluding China and Saudi Arabia), the share of reported remittances has roughly doubled in the last two decades to 1.6% of their aggregate GDP (see chart 1). However, remittances can play a much larger role in smaller EMs and frontier economies. For instance, in several countries in Central America and the Caribbean, remittances can be more than 20% of GDP. There are two main channels through which remittances benefit these economies. First, they can be a key source of funding for domestic demand, especially for lower-income households, which tend to be the main recipient of remittances. Consequently, remittances have been important drivers of poverty reduction, upward economic mobility, and sustained GDP growth in many countries. Second, remittances can be a large source of stable inflows of foreign currency, sometimes outpacing inward foreign direct investment (FDI) and other capital inflows. Therefore, remittances can be key determinants of exchange rates and overall balance of payments' stability.

As a result, in countries that receive a high share of remittances, such as those in Central America and the Caribbean, the trajectory of those flows can be among the most important factors that influence the economic activity. Moreover, remittances play a substantial role in our analysis of sovereign credit quality. In this report, we will address the following questions. What is the future trajectory of remittance flows? In which countries do remittances matter the most? And what impact can remittances have on our sovereign credit ratings?

Chart 1

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What Is The Future Trajectory Of Remittances?

First, it is important to acknowledge that because a large number of remittances occurs through unofficial channels, the actual amount of these flows may be widely underestimated by reported figures. That said, to understand the future trajectory of remittances, we can broadly classify the factors that influence those flows as cyclical, policy-related, and structural.

  • The main cyclical factors relate to economic conditions in the source country of remittances--a slowdown/acceleration in employment or wage growth that impacts migrant workers.
  • The policy-related factors refer to those that restrict/allow migrant work--immigration policy or policies that disrupt employment, such as the social mobility restrictions implemented by many countries during the COVID-19 pandemic.
  • The structural factors that influence remittance flows and take place throughout economic cycles, such as demographic trends and technological innovations.

The cyclical and policy-related factors are highly unpredictable, and can change in a relatively short period. Economies are subject to domestic and external economic shocks that influence the pool of disposable income available to be remitted. Policies for employment and immigration also change, which can affect the pool of workers willing and available to send money back home. The COVID-19 pandemic is a good example of how cyclical and policy-related factors influence remittances flows. In the U.S., a large counter-cyclical stimulus package, and relatively lax and short-lived social mobility policy restrictions helped the trend of outbound remittances to remain broadly uninterrupted throughout that period. Consequently, for countries that receive a large share of remittances from the U.S., remittances as a share of their GDP climbed during the pandemic years (see table 1). In contrast, EMs that typically rely more on remittances from countries in Europe and Asia, where mobility restrictions were stricter and longer, and stimulus measures were less generous than in the U.S., remittances as a share of their GDP fell during that period. This was the case in most of EM Asia and EM EMEA (see table 1). In those countries, to the extent that cyclical and policy-related factors go back to how they were before the pandemic, there is a case for those dynamics to contribute to an uptick in remittances in the coming years.

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Structural factors, however, especially those related to the demographic profiles of migrant workers, are somewhat easier to project. The latter profiles are likely to become less favorable for recipient countries than they have been in the past couple of decades. Most major EM will face eventually what many advanced economies are currently undergoing--lower fertility rates/slower population growth, and aging populations--which will dent remittance volumes. Fertility rates have been falling for several decades across most EMs. According to UN data, the fertility rate in developing nations fell from 2.9% in 2000 to 2.4% in 2022, and population growth has slowed from 1.5% to 0.9% over the same period. And both metrics are projected to continue heading lower in the coming years. The pool of young available migrant workers will likely be smaller than it has been in the past. The profile of workers abroad is also changing. For example, the median age of the foreign-born population in the U.S. is rising (see table 2). This could influence remittances if foreign-born workers develop over time deeper roots in their new country, and potentially build families there, reducing the pool of savings available to send to their country of origin (or their desire to do so).

Table 2

U.S. Population, median age in years, by sex, nativity and region of birth: 1960-2018
1960 1970 1980 1990 2000 2010 2018
All U.S. born 27 26 29 32 35 35 36
All foreign born 57 50 39 37 37 41 45
Mexico 43 36 28 29 31 37 43
East and Southeast Asia 39 34 31 35 39 44 48
South Asia 29 29 31 35 35 37 39
Oceania 37 33 33 36 37 41 42
Europe 60 61 56 53 49 51 53
Canada and Other North America 50 50 53 52 48 51 54
Caribbean 39 35 37 38 41 46 49
Central America 31 30 30 30 33 37 40
South America 33 30 32 34 37 42 45
Middle East-North Africa 54 38 30 35 39 43 43
Sub-Saharan Africa 36 28 29 32 35 37 38
All 29 27 29 32 35 37 38
Sources: Pew Research Center tabulations of 1960, 1970, 1980, 1990 and 2000 censuses and 2010 and 2018 American Community Surveys (IPUMS)

Mexico, which is now the second-largest recipient of reported remittances globally in U.S. dollar terms (roughly $60 billion a year, behind about $100 billion for India), is a good case because structural factors have likely helped boost remittance inflows, but those factors may become less favorable in the coming years. In Mexico, most of the growth in remittances in the last decade stemmed from the number of transactions, rather than the dollar value of transactions (see chart 2). This suggests that unless the average amount of remittances increases, if the growth in the number of workers moving abroad slows (or declines), so will the total amount of remittances.

Chart 2

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Finally, other structural factors that could have facilitated the increase in remittances in the last decade are technological innovations that have made remitting money easier and cheaper. The question regarding those factors is whether the boost to remittances is largely behind us, or if they will continue contributing to growth of flows in the coming years.

Where Do Remittances Matter The Most?

We can assess in which EM economies remittances matter the most by looking at where they fall within the two channels of transmission we previously introduced: the extent to which remittances fund domestic demand, and their importance as a source of foreign currency. Starting from the first channel, the share of remittances of total domestic demand in 2022 among the major EMs we analyze was the largest in the Philippines (7.9%), Vietnam (4.8%), and Mexico (4.1%; see chart 3). Mexico is the only one of these three countries, in which that share has increased during the last decade (it has doubled), benefiting from some of the cyclical, policy-related, and structural factors we described in the previous section.

Chart 3

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Regarding the second channel, inflows of hard currency can be very volatile, especially in countries with a large share of portfolio capital inflows, which are subject to rapid swings due to changing expectations on interest rates, inflation, growth, and exchange rates, among other factors. Remittances, on the contrary, tend to be less volatile, as they are not influenced as much by some of those factors. Therefore, arguably, a good comparison for remittances would be with another relatively stable, and typically large source of hard currency: FDI. In table 3, we subtract FDI from remittances, as a share of GDP, to calculate in which EMs remittances outpace FDI (denoted by a positive value). The Philippines stands out, with remittances averaging 6 percentage points of GDP higher than FDI in the last decade. In Mexico, remittances began consistently outpacing FDI only since 2019, averaging 1 percentage point of GDP above FDI inflows. The other two major EMs in which remittances are typically larger than FDI inflows are India and Vietnam, although by a smaller differential, on average of 0.5% of GDP or less during the last decade.

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Remittances Are Among The Most Important Macro Factors In Central America And The Caribbean

So far, we have been focusing on some of the larger EMs. Remittances can have a much greater impact on both domestic demand and external accounts in smaller EMs, where they can account for a much larger share of GDP. Most Central American and Caribbean economies are a clear example of that, where remittances account for over 20% of GDP (see chart 4).

Chart 4

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Unsurprisingly, in Honduras, El Salvador, Jamaica, Nicaragua, and Guatemala, remittances represented more than 15% of domestic demand (see chart 5). In several of those countries, remittances are actually higher than total domestic fixed investment. Consequently, large swings in remittances can drive large swings in GDP growth in these economies.

Chart 5

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Similarly, in most Central American and Caribbean economies, remittances are also among the highest sources of hard currency, usually only coming second to inflows from exports of goods and services (helped by large tourism sectors). Remittances in most of these economies dwarf FDI inflows, in some cases by a factor of 5x, or more (see chart 6). Therefore, remittances are a key driver not only for growth, but also for exchange rate and external account dynamics in Central American and Caribbean economies.

Chart 6

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What Role Do Remittances Have On Our Assessment Of Sovereign Credit Quality?

The economic and social impact of large remittance inflows can influence some of the factors that determine our sovereign ratings. Remittances often reach a wide segment of the population, mainly with modest income. Hence, much of the money is typically spent on private consumption, supporting GDP growth. The pace of economic growth, and its stability and sustainability, is a key rating factor.

Higher consumer spending can bolster tax revenues, to the extent that consumption taxes are effectively applied. That, in turn, could strengthen government finances and support the sovereign's fiscal profile, another factor in our credit rating.

However, the migration of a substantial number of working-age people to other countries also reduces the labor pool in the home country, which may limit its long-term growth prospects. In principle, the foreign-exchange inflows from remittances could be directed into private investment instead of consumption, contributing to future economic growth. However, in practice, most of the money goes to consumption, given the typically low income of most recipients.

Our external assessment of sovereigns, another rating factor, can also be influenced by substantial remittance inflows. The growing share of remittances of total current account receipts can help stabilize or improve the overall current account balance, limiting the sovereign's external vulnerability. Large inflows of foreign exchange may also help reduce exchange-rate volatility. The resulting improvement in external resiliency could have a positive impact on the credit rating.

Remittances do not have a direct impact on our institutional assessment of sovereigns. However, the out migration of a large segment of a country's workforce to seek jobs abroad could have potential long-term political implications. Some analysts posit that social and political conditions in some countries would have been much worse absent the 'safety valve' of emigration, potentially leading to worse political conditions and a weaker institutional assessment.

This report does not constitute a rating action.

Chief Economist, Emerging Markets:Elijah Oliveros-Rosen, New York + 1 (212) 438 2228;
elijah.oliveros@spglobal.com
Sovereign Analyst:Joydeep Mukherji, New York + 1 (212) 438 7351;
joydeep.mukherji@spglobal.com

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