SYMBIOSIS LAW SCHOOL

NOIDA

RESEARCH PROJECT
ON
REMITTANCES AND REAL EXCHANGE RATE
APPRECIATION

SUBMITTED TO SYMBIOSIS LAW SCHOOL

NOIDA

FACULTY GUIDEDr. Pushpa Negi

SUBMITTED BYSangeeta Yadav

(B.B.A.LL.B, First Sem)

Symbiosis Law School

(Off Campus Centre of Symbiosis International University)
Sector- 62, Block-A, Plot No-47/48, Noida-201301
U.P.-India Ph: +91 (0) 120 2405061,63.
Fax:0120 2405064, Website: www.symlaw.edu.in

DECLARATION

I Sangeeta Yadav, student of BBA I Semester of Symbiosis Law School, Noida hereby
declare that the MRP report titled REMITTANCES AND REAL EXCHANGE RATE
APPRECIATION is submitted by me in the line of partial fulfillment of course
objectives for the Masters of Business Administration degree.
I assure that this synopsis is the result of my own efforts and that any other institute for the
award of any degree or diploma has not submitted it.

DatePlace-

Sangeeta Yadav
(B.B.A.LL.B, First Sem)

CERTIFICATE
This is to certify that Sangeeta Yadav student of B.B.A.LL.B, First Semester of
Symbiosis law School, Noida has successfully completed his Project report. He has
prepared

this

report

REMITTANCES

AND

REAL

EXCHANGE

APPRECIATION under my direct supervision and guidance.

Date-

Dr. Pushpa Negi

Place-

(Faculty Guide)

RATE

ACKNOWLEDGEMENT
It is a great pleasure for me to put on records my appreciation and gratitude towards Dr.
C.J. Rawandale, Director for his immense support and encouragement all through the
preparation of this report. I would like to thank my faculty Dr. Pushpa Negi (Project
Guide) for her valuable support and suggestions for the improvement and editing of this
project report. Last but not the least, I would like to thank all the friends and others who
directly or indirectly helped me in completing our project report.

DatePlace-

Sangeeta Yadav
(B.B.A.LL.B, First Semester)

LIST OF CONTENT

S. No.

Topic

Page No.

Introduction

1-3

Review of Literature

4-12

Conclusion

13

References

INTRODUCTION
A remittance is a transfer of money by a foreign worker to his or her home country. The
process of sending money to remove an obligation is remittance. This is most often done
through an electronic network, wire transfer or mail. The term also refers to the amount
of money being sent to remove the obligation (sharma, jain, & Singh, 2007).
Remittances are playing an increasingly large role in the economies of many countries,
contributing to economic growth and to the livelihoods of less prosperous people (though
generally not the poorest of the poor). According to Lopez, Bussolo, and Molina (2007)
the remittance receivers often have a higher propensity to own a bank account,
remittances promote access to financial services for the sender and recipient, an essential
aspect of leveraging remittances to promote economic development. Aydas, and Neypati
(2005) concluded that top recipients in terms of the share of remittances in GDP included
many smaller economies such as Tajikistan (45%), Moldova (38%), and Honduras (25%).
Remittances are not a new phenomenon in the world, being a normal concomitant to
migration which has ever been a part of human history (Freund & Nikola, 2008).
Several European countries, for example Spain, Italy and Ireland were heavily dependent
on remittances received from their emigrants during the 19th and 20th centuries. In the
case of Spain, remittances amounted to the 21% of all of its current account income in
1946. All of those countries created policies on remittances developed after significant
research efforts in the field. For instance, Italy was the first country in the world to enact
a law to protect remittances in 1901 while Spain was the first country to sign an
international treaty (with Argentina in 1960) to lower the cost of the remittances received.
NRI remittances touched the magic figure of USD 24.1 billion in 2005-2006, making
India the largest recipient of personal money transfers in the world (Freund et al.,2008).
Remittances and flow of funds from migrant workers to India is a key resource in its
emerging economy.
A working report by the RBI on the cost of NRI remittances in May 2006 found that
money flows are determined by the economic health in the host country.The dollars
poured in from the Middle East workers in the 1980s, but the source of remittances has
now shifted to the West, mainly the USA. This shift in source, says the study, has also

meant that growth potential for remittance flows has now moved to traditionally high cost
economies which will affect cost of NRI remittances.

Recommendations by the RBI on Remittances

The RBI has advised banks to minimize costs of remittances by reducing their
charges at the domestic end and at the foreign end.

It has suggested an awareness programme through the banks' web sites to

encourage NRIs to use Indian banks or foreign banks having branches in India to
transfer money to India.

NRIs can affect the remittances in foreign currencies with instructions for
conversion into Indian Rupees at the Indian end to get the benefit of a better
exchange rate.

Moreover, public sector banks can explore the feasibility of setting up centralized
remittance receiving centre, extending the scope of real time gross settlement
between banks in India.

The report proposes to dispense with existing restrictions on the number of tie-ups
by banks with exchange houses and the number of drawee branches for rupee
drawing arrangements. However these relaxations could be extended to banks
only with sound risk management systems.

Remittance services offered by a host of commercial banks or authorized dealers,

and money exchange service providers have speeded up money transfers across
borders.

Technology (internet) has made cash transfers possible in minutes. Extending the
scope of existing electronic transfer facilities would help bring down remittance
charges further.

Exchange rate

The exchange rate (also known as the foreign-exchange rate, forex rate or FX rate)
between two currencies specifies how much one currency is worth in terms of the other. It
is the value of a foreign nations currency in terms of the home nations currency (Page,
2007). For example an exchange rate of 91 Japanese yen (JPY, ) to the United States

dollar (USD, $) means that JPY 91 is worth the same as USD 1. The foreign exchange
market is one of the largest markets in the world. By some estimates, about 3.2 trillion
USD worth of currency changes hands every day. Giuliano and Marta (2006) concluded
that spot exchange rate refers to the current exchange rate. The forward exchange rate
refers to an exchange rate that is quoted and traded today but for delivery and payment on
a specific future date.
Thus if you are doing a conversion from EUR into AUD, EUR is the base currency, AUD
is the term currency and the exchange rate tells you how many Australian dollars you
would pay or receive for 1 euro. Cyprus and Malta which were quoted as the base to the
USD and others were recently removed from this list when they joined the euro. In some
areas of Europe and in the non-professional market in the UK, EUR and GBP are
reversed so that GBP is quoted as the base currency to the euro (Vargas, 2009). In order
to determine which the base currency is where both currencies are not listed (i.e. both are
"other"), market convention is to use the base currency which gives an exchange rate
greater than 1.000. This avoids rounding issues and exchange rates being quoted to more
than 4 decimal places. There are some exceptions to this rule e.g. the Japanese often
quote their currency as the base to other currencies.

REVIEW OF LITERATURE
Amuedo, Pozo and Vargas (2007) examined how the remittances related to the exchange
rate, natural disasters and foreign aid in developing economies. By using panel VAR methods
they were able to compensate for both data limitations and endogeneity among variables.
They found that while foreign aid tends to appreciate the real exchange rate, remittances did
not have the same impact. They also detected an inverse relationship between the real
exchange rate and remittance amounts, with real exchange rate depreciation increasing
remittance inflows. Of particular interest was the observation that the Small Island
Developing States (SIDS) sub sample of countries behave differently from the full sample of
Developing Countries (DC) in a number of ways.

Desai, Kapur and McHale (2003) estimated the fiscal losses associated with the
emigrants, they first estimated what these emigrants would have earned in India, and then
integrated the resulting counterfactual distributions with details of the Indian fiscal
system to estimate fiscal impacts. Two distinct methods to estimate the counterfactual
earnings distributions are implemented: a translation of actual U.S. incomes in
purchasing power parity terms and an income simulation based on a jointly estimated
model of Indian earnings and participation in the workforce. The PPP methods indicated
that the foregone income tax revenues associated with the Indian-born residents of the
U.S. comprise one-third of current Indian individual income tax receipts. Depending on
the method for estimating expenditures saved by the absence of these emigrants, the net
fiscal loss associated with the U.S. Indian-born resident population ranges from 0.24% to
0.58% of Indian GDP in 2001.
Amuedo and Pozo (2004) analyzed the workers' remittances have the potential to inflict
economic costs on the export sector of receiving countries by reducing its international
competitiveness. Their findings raised concerns parallel to those raised by Dutch Disease
or Resource Boom models, where resource discoveries result in real exchange rate

appreciation and shifting of resources from the traded to the non-traded sectors of the
economy.

Bond, Hoeffler and Temple (2001) investigated the influence of migrant remittances on
two dimensions of the financial sector, namely, size and efficiency. Evidence suggested
that migrant remittances contribute to increasing the size and efficiency of the financial
sector. The study, in addition, examines the impact of remittances on financial sector size
and efficiency through the government ownership of banks channel. While the results
suggest that remittances lead to larger increases in financial sector size in countries in
which the government ownership of banks is lower and increases in efficiency in
countries in which the government ownership of banks is higher, the government is found
to play an important role in promoting financial sector development.
Chami, Barajas, Cosimano, Fullenkamp, Gapen, and Montiel (2008) stated that In
Sub-Saharan Africa, the flow of remittances had been far more stable than official aid
flows and direct financial investment (DFI) and did not decline even in conditions of
instability and poor governance. They were also more evenly spreaded among developing
countries than capital flows. Remittances seem to have contributed to poverty reduction
throughout Sub-Saharan Africa, leading to increased household investments in education,
entrepreneurship and health. Research had corroborated that remittances generate a
strong impact on reducing poverty. Noted in rural areas where most migrants originate. In
addition to supporting domestic consumption, remittances had promoted investments in
real assets including building schools and clinics, rather than formal sector financial
instruments.
Dollar, and Kraay (2004) investigated the link between remittance receipts and financial
openness. They developed a small model and statistically test for the existence of such a
relationship with a sample of 66 mostly developing countries from 1980-2005. They
accounted for the persistence of financial openness, initial conditions, trade openness,
institutional quality and domestic financial development. In addition, they applied a two-

step method akin to two stage least squares to deal with the potential endogeneity of
remittances. They found a strong positive effect of remittances on financial openness, i.e.
the more remittances a country receives; the more likely it will be financially open. This
positive effect was both statistically significant and economically large. These results
were supported by a counterfactual experiment.
Edwards (1998) revealed the relevance of remittances worldwide prompted the need to
examine the possibility of leveraging remittances for rapid attainment of economic
growth in the country. Available literatures revealed that the deployment of remittances
could have both positive and negative consequences. In a developing financial system
such as Nigeria remittances could be used to alleviate credit constraints and act as a
substitute for financial development. Even where it is employed to increase consumption,
it thus enhances production, boosts per capita income and consequently reduces poverty
and inequality.Conversely, where remittances are excessively dependent upon by a
country; it could dampen the morale of recipients in contributing to economic expansion.

Chami, Fullenkamp and Gapen (2008) explained that when constructing a

time series on remittances, the generally accepted practice in the literature had been to
aggregate three balance of payments categories: workers remittances, employee
compensation, and migrants transfers. They showed that inclusion of employee
compensation and migrant transfers is conceptually flawed and alters the behavioral
characteristics of remittances in empirical analysis, leading to serious misspecification
and faulty conclusions.
Comstock, Iannone and Bhatia (2009) analyzed that migrant remittances can play a
critical role in the economic development of low/middle-income countries. Remittances
to developing countries, which currently total over $300 billion annually, are generally
seen as an instrument to reduce poverty and inequality, to provide social benefits and
multiplier effects, and to act as buffers against economic shocks. However, the full
developmental potential of remittances is far from being realized. While the relevant

stakeholders, from the financial institutions to actors from the public sector and the civil
society, seem to appreciate the opportunity remittances represents, effective best practices
to harness this opportunity are still to be identified.
Levine, and Thorsten (2000) Legal and accounting reform that strengthens creditor
rights, contract enforcement and accounting practices boosts financial development and
accelerates economic growth. Their findings suggested that legal and accounting reform
that strengthens creditor rights, contract enforcement, and accounting practices boosts
financial development and accelerates economic growth. It is a product of
Macroeconomics and Growth, Development Research Group - is part of a larger effort in
the group to understand the links between the financial system and economic.
Giuliano and Marta (2009) studied one of the links between remittances and growth, in
particular how local financial sector development influenced a country's capacity to take
advantage of remittances. Using a newly-constructed dataset for remittances covering
about 100 developing countries, they found that remittances boost growth in countries
with less developed financial systems by providing an alternative way to finance
investment and helping overcome liquidity constraints. This finding controlled for the
endogeneity of remittances and financial development, did not depend on the particular
measure of financial sector development used, and was robust to a number of robustness
tests, including threshold estimation.
Lopez and Olmedo (2005) explained that migrants tend to increase their remittances
when their countries of origin experience economic difficulties. As a result, remittances
smooth the incomes of families and shield policymakers from the vagaries of the global
economy. Financial transfers from migrants are a form of insurance for developing
countries against exogenous shocks.
Acosta, Baerg and Mandelman (2009) examined the relationship between remittance
inflows, financial sector development, and the real exchange rate. They tested whether
financial sector development can prevent appreciation of the real exchange rate. In

particular, they show that well-developed financial sectors can more effectively channel
remittances into investment opportunities. Using panel data for 109 developing and
transition countries for 19902003, the authors found that remittances by themselves tend
to put upward pressure on the real exchange rate. But this effect is weaker in countries
with deeper and more sophisticated financial markets, which seem to retain trade
competitiveness.
Carlos, Fuentes and Herreraz (2007) studied that emigrant remittances have been
growing around the world since 1970, but in the past few years their growth rate has
enlarged significantly. They developed a stochastic, dynamic, general equilibrium model,
useful to explain the determinants of the real exchange rate. They studied the relationship
between the real exchange rate and the demand side of the economy; specially, its
relationship with remittances in a fully optimizing model. Model included adjustment
costs for capital intended to capture equilibrium in real exchange rate compatible with the
short run conditions and it generated a short-run equilibrium real exchange rate
appreciation, a tradable sector contraction, and a non-tradable sector expansion, similar to
those that were observed in national accounts data. The results also suggested that, in
Guatemala, economic agents perceived the observed shift in the remittances flow as
permanent.
Lartey, Mandelman and Acosta (2008) showed that rising levels of remittances have
spending effects that lead to real exchange rate appreciation and resource movement
effects that favor the non-tradable sector at the expense of tradable goods production.
These are two characteristic of the phenomenon known as Dutch Disease. The results
further indicate that these effects operate stronger under fixed nominal exchange rate
regimes.
Singer (2009) argued that the international financial consequences of immigration exert a
substantial influence on the choice of exchange rate regimes in the developing world.
Over the past two decades, migrant remittances have emerged as a significant source of
external finance for developing countries, often exceeding conventional sources of capital

such as foreign direct investment and bank lending. Remittances are unlike nearly all
other capital flows in that they are stable and move counter cyclically relative to the
recipient countrys economy. As a result, they mitigated the costs of forgone domestic
monetary policy autonomy and also serve as an international risk-sharing mechanism for
developing countries. The observable implication of these arguments was that remittances
increase the likelihood that policymakers adopt fixed exchange rates.
Chudik and Mongardini (2007) estimated that the relationship between grants
and remittances and the equilibrium real exchange rate in Sub-Saharan African (SSA)
countries using panel techniques. The results indicated that grants and remittances are not
associated, in the long run, with an appreciation of the real effective exchange in SSA and
are therefore not likely to give rise to Dutch disease effects. These findings suggested that
grants and remittances may be serving to ease supply constraint or boost productivity in
the non-tradable sector in the recipient economies.
El-Sakka, and McNabb (1999) considered the macroeconomic determinants of
migrants' remittances to their countries of origin. In contrast to some previous analyses,
they found, using data for Egypt, that both exchange rate and interest rate differentials are
important in attracting remittance flows through official channels. They also found that
imports financed through remittance earnings have a very high income elasticity which
suggests either that these imports are consumer durables and luxury goods or that they are
undertaken by higher income groups.
Freund, and Nikola (2008) explored the determinants of remittances and their associated
transaction costs. They found that recorded remittances depend positively on the stock of
migrants and negatively on transfer costs and exchange rate restrictions. In turn, transfer
costs were lower when financial systems were more developed and exchange rates less
volatile. The negative impact of transactions costs on remittances suggested that migrants
either refrain from sending money home or else remit through informal channels when
costs are high. They provided evidence from household surveys supportive of a sizeable
informal sector.

Lopez, Molina, Luis and Maurizio (2007) indicated that remittances have a positive
impact on a good number of development indicators of recipient countries. Yet when flew
were too large relative to the size of the recipient economies, as those observed in a
number of Latin American countries, they may also brought a number of undesired
problems. Among those probably the most feared in this context is the Dutch Disease. It
explored the empirical evidence regarding the impact of remittances on the real exchange
rate. The findings suggested that remittances indeed appear to lead to a significant real
exchange rate appreciation. It also explored policy options that may somewhat offset the
observed effect.
Durlauf, Johnson and Temple (2005). accounted for the appreciation of the real
exchange rate in Mexico between 1988 and 2002 using a two sector dynamic general
equilibrium model of a small open economy with two driving forces: (i) differential
productivity growth across sectors and (ii) a decline in the cost of borrowing in foreign
markets. These two mechanisms accounted for 60 percent of the decline in the relative
price of tradable goods and explain a large fraction of the reallocation of labor across
sectors. They did not find a significant role for migration remittances, foreign reserves
accumulation, government spending, terms of trade, or import tariffs.
Adams and John (2003) found no evidence that developing countries with higher levels
of poverty produce more migrants. Because of the considerable travel costs
associated with international migration, international migrants come from those income
groups which are just above the poverty line in middle-income developing countries.
Finally, international remittances -- defined as the share of remittances in country GDP
have a strong, statistical impact on reducing poverty. On average, a 10 percent increase in
the share of international remittances in a countrys GDP will lead to a 1.6 percent
decline in the share of people living in poverty.
Aydas, and Neypati, (2005) indicated that black market premium, interest
rate differential, inflation rate, growth, home and host country income levels, and periods

of military administration in Turkey had significantly affected these flows. Among them,
the negatively significant effects of the black market premium, inflation, and a dummy
for periods of military administration point at the importance of sound exchange rate
policies and economic and political stability in attracting remittance flows. In addition,
both investment and consumption-smoothing motives were observed, though the former
of which appears more prevalent after the 1980s.
Page and Sonia (2006) reviewed evidence on how migrants contribute to the economic
development of their countries of origin. In addition to describing the state of knowledge
regarding flows of people and migrant remittances worldwide, it focused on the current
literature dealing with the development impact of transfers of money, knowledge, and
skills by migrants back to their home countries. The paper also examined the complex
question of the impact of highly skilled migration on labor sending countries.

Demirg and Levine (2008) investigated the effects of exchange rate uncertainty and
political risk, after controlling for the conventional macroeconomic determinants, on
remittances transfers into eight Latin American countries during the period of 1990-2006.
The results suggested that an increase in exchange rate uncertainty reduces remittances
flows into these countries. Furthermore, an increase in political risk seems to have a
negative but statistically insignificant impact on remittances transfers. Based on the
findings of this paper, they said that governments of the remittance receiving countries
can influence the inflow of remittances by means of adopting appropriate macroeconomic
policies to reduce exchange rate uncertainty and also by improving their political
environments.
Easterly, Levine, and Roodman (2004) suggested that contradictory findings have
emerged when looking at the remittances growth link because previous studies have not
correctly controlled for endogeneity. Using Dynamic Data Panel estimates they found
that remittances exert a weakly positive impact on long-term macroeconomic growth.
The paper also considered the proposition that the longer term developmental impact of
remittances is increased in the presence of sound economic policies and institutions.

Greiner, Semler and Gong (2004) analyzed empirically the role of financial sector
development (FSD) in the stimulating effect of remittances on home country investment.
This is important, as investment is one of the main components of long-term growth.
They used longitudinal data that cover over 70 countries over the 1970-2005 periods.
Their results indicated the presence of a robust quadratic effect: When FSD is low; more
FSD leads to a higher (positive) effect of remittances on investment. With further
increases of FSD, the effect of remittances on investment, although still positive,
decreases. They explained those results with a model that includes transaction cost and
openness effects and conclude with differentiated economic policy implications.
Giuliano, and Ruiz (2009) explained that high-remittance recipient countries with
comparatively better developed financial systems can more effectively direct remittance
flows toward investment activities. They predicted, therefore, that upward pressure on the
real exchange rate is weaker in countries with comparatively better developed financial
sectors. This study was the first to directly tackle the interactive relationship between
remittances, the real exchange rate, and financial development in developing countries.
Giuliano and Ruizz (2006) found evidence that remittances boost growth in countries
with less developed financial systems. They interpreted their result by noting that
remittances may provide an alternative way to finance investment and help overcome
liquidity constraints.
Gupta, Pattillo and Wagh (2009) argued that financial development and market
competition stemming from additional bank entry can stimulate higher remittance flows
to the country by reducing transaction costs.

CONCLUSION

Remittances are the only means of survival for millions of poor households worldwide
where money sent to beneficiary families enable them to afford not only the basic
necessities of life which are otherwise lacking or inaccessible, but also a degree of
economic empowerment. Remittances are emerging as an important source of external
development finance. They have been growing in both absolute volumes, as well as
relative to other sources of external finance. The RER (Real Exchange Rate) refers to the
purchasing power of two currencies relative to one another.
This research investigated that in case of India and Brazil, relationship exists between
remittances and real exchange rate appreciation but in case of China and Japan, no
relationship exists between remittances and real exchange rate appreciation. On the basis
of findings of the research, it can be concluded that exchange rate does not vary
according to the change in the remittances in case of China and Japan but in case of India
and Brazil remittances affect exchange rate positively which directly affect the economy.

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