Development Nepal

Development and Stability

 Article

December 25, 2006

Explaining the remittance behavior and the role of remittances in the GDP growth in Nepal

 

-Hari Sharma, Trinity College, USA

 

 

Abstract

Remittances have played a significant role in poverty reduction in most of the developing countries around the globe. However, there have been few studies on the impact of remittances on the growth of GDP of a country. We use the data from World Bank to estimate the impact of remittances on the GDP growth of Nepalese economy and also try to find out why people remit back home. We find that remittances are more of compensatory in nature and hence, are the reflection of a situation in the home country. Better economic situations inhibit remittance flows while poor performance of the economy will increase the flow of remittances. Since most of the remittances have been used for consumption purposes in Nepal, it has a negative impact on the growth of GDP in Nepal.

 

Summary

It is no wonder that remittances have played a pivotal role in the poverty reduction in most of the developing countries and it is true about Nepal as well. Nepal received an estimated amount of around US$ 900 million in the year 2004(Nepal: Selected Issues…IMF,2006) which is about 12 percent of its GDP.  Considering the large number of undocumented workers abroad, it is (Seddon, David, 2001) estimated that remittances could have accounted for more than 13% (upto a maximum of 25%) of GDP in the mid-late 1990s.With such a substantial inflow of remittances, Nepal ranks in the top 20 recipients of remittances expressed as a percentage of GDP(IMF). Despite a slowdown in the growth of GDP, domestic consumption has not subsided, thanks to the large inflow of remittances.  Remittances have played a momentous role in poverty reduction in Nepal from 42% to 32% in the past one decade.

 

Nepal Living Standard Survey (2003) shows the percentage of households receiving remittances increase from about 23% in 1995/96 to about 32% in 2003/04. Furthermore, the share of remittances in total household income of these remittance-recipient households increased from about 27% in 1995/96 to 35 % in 2003/04. Moreover, the absolute size of per capita remittances increased by more than threefold during the same period. These simple facts alarm us of the significant role of remittances in Nepalese economy.

 

Yet, the role of remittances in the growth of the GDP remains in the dark. Different papers have come to different conclusions and this paper tends to agree with the group of researchers (including Chami, Fullenkamp, Jahjah, 2005) who believe that remittances are more of compensatory in nature. So, if remittances are compensatory in nature, they should have a negative correlation with GDP growth. On the other hand, if remittances do act like investment flows, they will have positive correlation with the GDP growth. We used simple OLS technique to estimate the equations and we came to a conclusion that remittances do not behave like investment flows but rather like compensatory transfers.

 

Unlike the findings by Paola and Ruiz-Arranz from the IMF, we did not find a positive impact of remittances on growth in Nepal. Remittances had a negative correlation with the per capita GDP growth but a strong positive correlation with labor force and war variable.  We know that in general Nepal has poor access to credit facility and yet, the impact on growth is significantly negative. The trend line shows that the amount of flow of remittances and the per capita GDP growth are moving in opposite directions.

 Note: Remittances are expressed in natural logs. Black lines represent the linear trend.

As reported by the Central Bank of Nepal (Khatiwada, 2005), the reasons could be that most of the remittances has been spent on consumption goods. Moreover, the import of consumption goods is consistent if not increasing despite the poor economic growth.  The ever widening balance of trade gap is another matter of concern to the country.

 

Another fact we have found is that the remittances are a statistically significant negative function of money supply in Nepal. Increase in money supply tends to suppress the inflow of remittances.  And, it is also true that remittances have surged during the war period implying the compensatory nature of the transfers. Hence, our results align more with the research done by Chami and colleagues from the IMF.

 

However, we do not want to claim our results for certain. We present our conclusion for debate among the economists. There are several other ways through which remittances could have had an impact on the growth. For instance, the increased consumption expenditure could have had a demand led growth but we do not explore it. Furthermore, we do not analyze the benefits of remittances among the most poor. The Nepal Living Standard Survey (2003) suggested that the percentage of poorest households receiving remittances increased from 19% in 1995/96 to 29% in 2003/04. This could have helped a lot in poverty reduction.

 

Thus, remittances raise a lot of questions to the policymakers. While they have helped in poverty reduction, they do not seem to act like investment flows and thus, do not aid to the growth of GDP directly. Though remittances have helped in the reduction of poverty, there are several challenges.

 

First of all, we should be able to gather a more comprehensive data set for remittances. Informal channels of remittance transfers are difficult to record but there should be a household survey from time to time to capture those remittances. Detailed household survey should be able to tell us the areas where remittances are spent and the subsequent impact on those areas. For instance, surveys should capture the impact on the wage levels of the areas receiving remittances. Further efforts are essential if we want to better account the amount of remittances and the subsequent impacts.

 

Second, remittances may not be sustainable. So, relying on remittances may not be a wise policy. Fall in remittances could have had severe impacts on exchange rates, foreign currency deposits and consumption all at once. This could have a negative multiplier effect on the economy. While we should encourage remittances, we should also create employment opportunities within our country. In addition, most of the emigration is restricted to a limited number of countries including those in the Middle East. Nepal should try to diversify its export of labor if it wants to ensure that the remittances are sustainable.

 

Third, government should work towards creating better opportunities for investment of remittances. Government should facilitate investment by building infrastructures. There should be construction of roads and bridges to ease transportation. Efforts should be made to build more hydro-power stations. Telephone system should be expanded throughout the country. These all developments would facilitate commerce and trade and encourage more employment within the country. Remittances would then be invested rather than spending on consumption goods.

 

Fourth, as pointed by Khatiwada (2005), efforts should be made to make remittances pro-poor. Most of the remittances among the poor also go to the so-called higher caste people. Those people of the so-called lower caste should also have access to remittances and credit. For this, the government should help the so-called lower-caste people in their dreams of landing into foreign employment. Loans to pay for the initial travel and other expenses should help these poor of the poor. This is essential if we want to avoid the vicious cycle of poverty among the poor.

 

Fifth, the situation in the country is volatile. Peace process has begun and hopefully the country will see better expectations in the near future. Should the peace process fail, we will face chaos in the economy. So, at the planning level, one should formulate policies to adapt to both situations: peace and war. Hence, the policies being formulated at this juncture should be of short term nature with sufficient ground to accommodate unforeseen future situations. Remittance flows have remained strong and there should be smart decisions to tap these resources. If the war does in fact end, then long term policies should be designed to use remittances for investment purposes.

 

While remittances do not seem to aid to GDP growth in Nepal; they are important in poverty reduction. But, we should not be too much obsessed with these results because we have several limitations of the research. Yet, the findings are important for relevant policy formulation. The national planning commission should design policies so that remittances could in fact be utilized for investment purposes rather than being spent on consumption at large.

 

Note: I would like to thank Prof. James Wen for his immense help and support, without which I would not have been able to write this up..