Are remittances inflationary?
%change = growth rates, Remit= Remittance growth, RM=Reserve money growth, M2 =broad money growth, Multiplier = RM/M2, inflation rate = %change in CPI
AFTER the CPD economist Fahmida Khatun concluded her panel presentation in the Bangladesh Brand Forum at the development conference at Harvard on October 9, there was a flurry of feedbacks and exchanges. Being the last to raise a hand, I had very little time to present my comments on remittance vis-à-vis inflation in response to both Fahmida and City Bank's Mamum Rashid. The concerns about the potential adverse consequences of continually increasing remittances -- in addition to inflationary pressure -- are certainly worrisome. Obviously, given the time constraints, all I could do is assure the participants of an article on the issues raised. Remittances are a catalyst in Bangladesh's poverty alleviation and economic growth. Nearly 6 million people work abroad, sending home over $8 billion a year -- second only to the $9 billion earned by ready-made garment exports. A number of studies argue that émigré workers' remittances -- in addition to exerting inflationary pressure -- tend to discourage domestic labour supply or work incentives by remittance receiving households (RRH) and promote dependency on remittance inflows for current consumption. Besides, against these forex inflows, there are no offsetting domestic output production. More recent empirical studies, however, lends credence to the realisation that remittances contribute to economic growth and development by facilitating RRHs to surmount liquidity constraints and finance productive investments. However, the fear of remittance driven inflation in Bangladesh and elsewhere is genuine and some recent newspaper articles have also heightened that concern (Taslim, Oct. 11, DS). If 100% of the forex remittances are monetised in domestic currency while no active sterilisation by Bangladesh Bank's (BB) reverse repos operations are in effect, and the recipients squander the entire remittances in consumption, an accelerated inflation will be unavoidable. In that vein, changes in the weekly or monthly money supply will = 4.65 X the change in monetary base (4.67 is the average of 7 quarter M2 money multiplier). In reality, recipients as a group never withdraw the entire remittances in cash; instead they hold a significant amount in interest bearing accounts and assets and draw funds as needed. Funds in these accounts shouldn't be interspersed with traditional savings -- they're funds to spend as needed while earning interest to partly offset inflation risk. The table displays a steadily decreasing inflation rate from 11.59 % in Q2-2008 to 5.04% in Q3-2009. Quarterly changes in remittance growth reveal no systematic pattern resonating either with CPI inflation and money growth (with or without lag effects) or the reserve money growth. The money growth over the same period also shows a declining trend with some minor variability indicating BB's well-guarded active sterilisation operations. However, there's a limit to BB's sterilisation activism without risking money and credit crunch and a possible recession. The tamed inflation may also be credited to global recession driven lower import prices (oil and other inputs), and domestic bumper crops (favourable weather driven higher productivity of land and labour). Besides, remittances may not be inflationary under certain conditions and may depend on how they're expended by RRHs and what role the recipient's government plays. Using a theoretical model Christopher Ball et. al. (2009) shoed that remittances temporarily increase inflation and domestic money supply (to offset increased money demand) under a fixed forex regime but temporarily decrease inflation and leave the money supply unchanged under a flexible regime. Using annual and quarterly data for seven Latin American countries, the study has shown that the two theoretical assertions are empirically borne out. Since inflation doesn't affect every consumer uniformly, economists prefer to examine if remittances have any effects on relative price variability (RPV) -- one that is more relevant for most households than observed CPI inflation, which reflects average price changes of representative market basket of consumer goods. A March 2009 study by Columbia Professor Ricardo Reis and Princeton Professor Mark Watson suggests that relative price changes (RPC) are much more important for determining what happens to the broad CPI inflation. For example, the recent deflationary phase was heavily influenced by falling energy prices. It's not unreasonable to expect the resulting expenditure patterns from remittances to have differential effects in various markets with concomitant implications for RPCs as well. Durand et al (1996) used data for 30 Mexican communities and found that 10% of total remittances received were spent on productive investment, 14% on housing, and a lopsided 76% on consumption. Bear in mind that consumption spending has multiplier effects too. Higher consumption demand leads to expansion of production by firms through capital investment and higher level of employment. Zarate-Hoyos (2004) used data from the Mexican Income and Expenditure Survey for 1989 to compare the consumption patterns of RRHs with non-RRHs. He found that despite RRHs having lower average expenditures in most spending categories, they divert a relatively higher proportion of spending to equipment and housing purchases, and home improvements. These expenditures, as the author inferred, may have benefitted the economy through labour and goods markets across Mexico. Ulyses Balderas (2005), and others, analysed the effects of remittances on the distribution of RPCs in Mexico over the 1980 2005 period. While they found little evidence of any significant impact of remittances on inflation and RPV for the entire sample period, remittances, however, seem to have positively impacted inflation after 1994. Furthermore, they found a positive relationship between inflation and RPV regardless of sample period and model specification. Since high inflation and RPV involve welfare costs, the Bangladesh government should devise policies to motivate RRHs to channel a significant amount of remittances for productive investments rather than for consumption, like Ecuador and other Latin American countries.
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