India typically receives three times as much in remittances – cash sent home to family members by migrants – as it does in foreign direct investment. In some developing countries the disparity is even bigger. Yet most financial institutions are failing to capitalise on this market, charging high transfer fees but missing the opportunity to offer additional financial services either to senders or receivers
Perhaps the fastest way to eliminate poverty and share prosperity is to allow the poor to migrate to a richer destination. A person’s income multiplies instantaneously, often by a factor of 10 or 20; and the income gains are shared with family members and friends back home, through remittances. These remittances are used to purchase food, housing and health care for the family, education for children and business investments. Over time, migrants facilitate exports and imports between countries. Those more skilled also share their knowledge and expertise with people back home. Some return home after years of working abroad, bringing with them skills and savings.
There are more than 200 million international migrants. The size of the diaspora, including the second and third generation descendants of these migrants, is significantly larger. International remittance flows to developing countries exceeded US$400 billion in 2012, almost four times the size of official development assistance (figure 1). The true size of remittances, including unrecorded flows through informal and formal channels, is larger, perhaps a multiple of the current level in many poor countries.
In addition, remittances tend to be stable and resilient during financial crisis. Unlike private capital flows, which tended to fall precipitously during the global financial crisis in 2009, remittances to developing countries declined by less than five percent and recovered quickly afterwards.
Migrant remittances provide a lifeline to many countries. India received $70 billion in remittances in 2012, more than three times the size of foreign direct investment (FDI). Egypt received $21 billion, three times the value of its revenue from the Suez Canal. In many smaller countries, such as Tajikistan or Liberia, remittances are between one-third and one-half of the national income.
Since remittances are personal funds, governments cannot dictate their use funds for specific productive purposes (such as buying tractors). Nor should they do so, because that interferes with individuals’ incentives and reduces welfare. Yet, governments can facilitate the flow of remittances by reducing the cost of sending money, and promote access to savings, loans and health insurance products linked to remittances. They can even reduce sovereign borrowing costs by using future remittance flows as collateral. And they can issue diaspora bonds to mobilise diaspora savings.
Given modern technologies, it is hard to believe that sending money costs nine per cent on average and, in some south-south corridors, 15-20 per cent of the principal amount remitted. The fee structure is also highly regressive – the smaller the remittance, the higher the fee. International regulations, especially anti-money laundering and countering the financing of terror (AML/CFT) regulations, are increasing the cost of using mobile phone technology and internet to send money across international borders. These regulations are also preventing global banks from operating bank accounts of money transfer companies, thus contributing to higher costs. Exclusive partnership agreements between national post offices and major money transfer companies are increasing the market power of the latter and stifling competition from new players. Capital controls are preventing outward remittances from many developing countries. And exchange controls, together with dual exchange rates, are discouraging remittances in many countries.
Since 2009, the G20 has adopted a goal of reducing remittance costs to five percentage points in five years. Average remittance costs have fallen from roughly 12 per cent to around nine percent currently. But there is more work to be done, especially in many south-south corridors and some low-volume north-south corridors involving small countries.
For many poor people, the only point of contact with the financial system is through sending or receiving remittances. After three or four trips to a bank or credit union, the sender or receiver often decides to open an account in that financial institution. This trend has not yet been fully harnessed by the proponents of financial inclusion for all. Promoting account-to-account transfers would help to mobilise savings and match savings and investment opportunities. Yet, the current trend, as mentioned earlier, is for many international banks to close the correspondent banking accounts of money service businesses, for compliance with stringent financial regulations. These regulations require rebalancing. Remitters and recipients who opened bank accounts, would soon also be customers for housing or car loans, which would benefit both banks and their customers.
Of particular significance is a need to link remittances to micro-insurance, especially health insurance for the poor. The circle of poverty is often perpetuated by debilitating illnesses that many household heads face in middle age. Health insurance for such illnesses can be easily promoted by facilitating payment of premiums by migrants using remittance channels.
Besides sending remittances, diaspora members accumulate substantial savings in destination countries, estimated to be over $400 billion annually. Most of it is invested in bank deposits in destination countries earning little or no interest. These savings could be mobilised by selling diaspora bonds that offer an interest rate of three to four percent in dollar terms. Diaspora members would be interested not only in the financial returns, but also in the development projects that such bonds could finance in origin countries.
Diaspora bond interest rates can be significantly lower than those on institutional bonds because diaspora members have a lower country risk perception than institutional investors. Also, the price of diaspora bonds held by a large number of small retail diaspora investors is likely to be less volatile than institutional investments.
These bonds can be marketed primarily to diaspora members – but not solely. The bonds must be registered under the securities act of the destination country. For prudential debt management, bond proceeds must be invested in projects that generate adequate financial returns. Financing of international airports or high-speed trains, power generation and roads are likely to attract diaspora financing via diaspora bonds. Some countries are considering paying off higher-cost debt using diaspora bond proceeds, to reduce the interest burden. Before issuing a diaspora bond, however, consultations with the diaspora are necessary to understand their abilities and attitudes toward investing in their home countries.
