As U.S. President Barack Obama gears up for his sixth State of The Union address tonight (Jan. 20), the leader of the free world will likely focus his efforts on the state of the U.S. economy. After all, when America’s economy crashes, the rest of the world slumps, too. And when the rest of the world’s economy slumps, so does America’s. But just what does the global economy look like today?
World Bank Group released a report last week (Jan. 15) titled “Global Economic Prospects, January 2015: Having Fiscal Space and Using It” which addresses a key question related to the payments industry and the future of the global economy: “Can remittances help promote consumption stability?”
But first, let’s look at what the report suggests is driving the global outlook: “Soft commodity prices; persistently low interest rates but increasingly divergent monetary policies across major economies; and weak world trade,” are the key factors, according to the report. Overall, global growth last year was lower than anticipated, as the Gross Domestic Product (GDP) grew 2.6 percent in 2015 and is predicted to grow 3 percent in 2015 and 3.3 percent in 2016. The growth overtime is estimated to come from the gradual recovery in high-income countries, dwindling oil prices and “receding domestic headwinds in developing countries.”
So where do remittances come into place? Since GDP is used to gauge the health of a country’s economy, there’s a direct link to a country’s economic forecast and the amount of money being transferred from a foreign market to help boost GDP. World Bank Group’s essay on remittances as part of report details the acyclical characteristics of remittances and examines how payments made to developing nations play a critical role in terms of GDP and overall development of those emerging countries.
“The relative importance of remittances as a source of external finance is expected to increase further if capital inflows to developing countries slow down as interest rates in advanced economies normalize, or if growth in developing economies remains weak which affects the ability of senders to transfer money to family members in another. Those funds are typically associated with significant development impacts such as accelerated poverty alleviation, improved access to education and health services, and enhanced financial development, as well as multiplier effects through higher household expenditures,” the report concluded.
Even during period of financial volatility, remittances have remained stable and acyclical, the report said, which suggests they play a “stabilizing role” during times of economic challenges. Even when capital flow was low, the report suggests that remittances help balance the market fluctuations. The report points to a time when capital flow was low but remittances increased.
“For example, while capital inflows to emerging markets on average declined about 25 percent during the initial year of a sudden stop episode, remittances increased by 7 percent during the same year,” the report said. “The contrast was even more evident during the crisis of 2008 when remittances increased over 10 percent even as capital inflows fell by over 80 percent. The analysis suggests that the stabilizing effects are greater for remittance-receiving countries with a more dispersed migrant population.”
To understand how continuing to transfer money into emerging nations and developing economies influences the overall global economy and the GDP of those specific nations being impacted by remittance, it’s also important to break down the issue by three key items, according to the report. These include:
- Magnitude: “Remittances to developing countries have been significant both as a share of GDP and compared to Foreign Direct Investments (FDI) and official development assistance. Since 2000, total remittances have averaged about 60 percent of the size of total FDI. A large and growing number of emerging and developing markets — the Remittance and Capital Flow Intensive countries — have received substantial inflows of capital as well as remittances over the past decade. For developing economies, remittances amount, on average, to close to 80 percent of reserves. For a large number of countries, remittances constitute the single largest source of foreign exchange. The rising trend of remittances is likely to persist given the large and growing stock of international migrants worldwide (more than 232 million at present).”
- Drivers: “There is considerable overlap between individuals’ motives to remit and other longer term and institutional drivers of remittances. Factors that affect migration decisions, the economic and policy environment in the origin and recipient countries, and transactions costs associated with intermediation of remittances all influence the volume and frequency of remittances. Remittances are closely related to migration patterns at the macroeconomic level, driven by a host of factors, including economic opportunities in the migrants’ host and home countries, existing migrant stocks and networks, cost of emigration, and barriers to immigration.”
- Cyclical Features: “Remittances appear to be a more stable source of external finance than other inflows, including ODA. They are also less correlated with the business cycle than FDI and total inflows. Because capital flows such as FDI and debt flows are often pro-cyclical, they can exacerbate output fluctuations and contribute to the volatility of consumption in developing countries when abruptly leaving the country. Although remittances are not necessarily countercyclical, they have the potential to at least provide some stability for the balance of payments, and hence for economic activity more generally, when capital inflows decline.”
According to World Bank Group’s report, the cost of remittances has a lot to do with retail cross-border money transfers and their impact on the global economy. Because the average price of cross-border retail transfers has been dipping, the flow of remittances remains high. Because of their acyclical nature, remittances have the ability to support consumption in times of economic adversity, the report said, which is particularly import in developing countries where household spending comes from money transferred in via remittances.
“The average cost of sending about $200 U.S. fell from 9.8 percent in 2008 to 7.9 percent in the third quarter of 2014,” the report said. “It will be important to reduce such costs further by ensuring competition in money transfer services, establishing an appropriate regulatory regime for electronic transfers, and supporting improvements in retail payments services.”
Remittances also work much like capital flow in making indents in income during times of need.
“In principle, remittances, like capital flows can help buffer consumption from short-run fluctuations in income. The ability to reduce fluctuations in consumption is an important determinant of economic welfare,” the report said. “In the case of capital flows, short-term foreign and output growth is added to the regression, and measures the extent to which remittance flows help delink domestic consumption from domestic output growth.”
By providing easier access to financial services that otherwise would not be possible, the impact of remittances on the global economy is certainly prevalent. Even if the increase of remittances is small during an economic slump, a greater amount of remittance receipts will be used for consumption, which keeps the local economy moving during times it needs it most, the report said. Without such financial transfers into the developing countries, it could mean economic collapse — weakening the global economy.
“Remittance flows to developing economies are projected to continue to expand, while private capital flows might moderate as global interest rates begin rising or if growth in developing economies remains subdued. Remittances are generally a more stable source of external funding that is less correlated with the domestic business cycle than other types of private flows. Given these tendencies, remittances to heavily reliant developing countries can help ease liquidity constraints, improve access to financial services, and smooth household consumption, especially during periods of financial stress,” the report concluded.
And in a time when the global economy is uncertain, the more money transfer may be the only way to keep emerging nations afloat and keep its citizens able to remain consumers.
“The global economy is still struggling to gain momentum as many high-income countries continue to grapple with the legacies of the global financial crisis and emerging economies are less dynamic than in the past,” wrote Kaushik Basu, Chief Economist and Senior Vice President for The World Bank.