Parasitical State: Economic Consequences of Remittance

By Anjan Panday/Prakash Kumar Shrestha

Monday, 13 February 2012 11:54

nepalnews.com Increasing dependency on remittances has resulted in a number of negative consequences for the Nepalese economy, making it a parasitical economy suffering from the ‘Dutch-disease’ type effects. Remittance inflow has been growing substantially in recent years with a growing outflow of workers for foreign employment. Evidently, the inflow of remittance has contributed to reduce the level of absolute poverty, as found in the recent living-standard survey, even amidst political instability and economic stagnation. Despite this, increasing dependency on remittances has resulted in a number of negative consequences for the Nepalese economy, making it a parasitical economy suffering from the ‘Dutch-disease’ type effects. In the last decade, remittances have grown tremendously. Remittance as a percentage of GDP was 2.03 in 2000, which reached 14.9 by 2005, and 23.2 in 2009. The number fell marginally to 22.09 in 2010. This number does not include remittances through informal channels and the contribution of a large number of workers in India. If we also consider these unrecorded remittances, it becomes clear to see what holds key for the survival of our economy. Remittances in Nepal primarily have three economic implications. First, it is a stable and growing source of the foreign-exchange reserve in the country. This is vitally important from the point of view of macroeconomic stability. Second, it is the important source of income of more than 56 percent of households. Third, when remittances are received through financial institutions, it increases money/credit base and enhances liquidity in the system. While increases in the household income directly increase the amount of disposable income, the expansion of liquidity in financial institutions tends to ease credit availability for individuals and businesses. The cumulative effect of the two can be seen in the rise in consumption in recent years. Most of demand generated from these spending is, however, met through imports.  With a low-level of domestic production, increases in imports increase trade deficit. An overvalued real exchange rate deteriorates this situation even further, since it promotes imports while discouraging exports. In our case, overvaluation is largely driven by the rigid peg with the Indian currency for a long time. Finally, increases in consumption also put pressure on prices to rise, helping the currency to be overvalued. Apart from its impact on consumption and trade, increases in remittances have not translated into productive investment. In the absence of productive investment, caused primarily by collapse in the business and investment environment, remittances have continued to just facilitate a consumption-based city-centric economy.  Increasingly, our economy is turning into a retail-trading hub, where money spent generates less in productive investment and more in imports. A bulk of imports goes into meeting the basic needs of our society like petroleum products and primary goods. Ironically, the most adverse impact seems to have been on the industrial sector. Our industrial sector has already been losing its strength despite trade liberalization, accession to WTO, and membership to regional trading blocs like SAFTA and BIMSTEC. With increase in remittances and the possibility of overvalued exchange rate, this sector is further undermined, especially those with export potential.  Add to this the power shortage and never ending labor conflict. This makes clear to see why we have been losing when our neighbors like Bangladesh has been maintaining a robust economic growth despite political instability. Taken together, the impact of remittances on household, and businesses has resulted in a larger trade deficit.  For example, trade deficit as a percentage of GDP was 9.14 in 2000, which increased to 14.9 in 2005, and 21.1 in 2009. We will continue to see further worsening of the situation if the current situation persists. In fact, we are highly dependent on remittance and remain absolutely vulnerable to any shock that will depress remittances flow for even a modest period of time as we saw recently.  In the aftermath of the 2008 financial crisis, the growth rate of remittances slowed significantly—from 46% to 11% between 2007/08 to 2009/10—which immediately hit our current account.  The impact was severe enough to turn the overall balance of payments into negative, prompting the central bank to seek an IMF-loan in June 2010. At the same time, the banking system witnessed serious liquidity crisis, almost ensuing instability in the financial sector. Thus, there exists a loop starting from remittances to consumption to trade deficit, and to the financial sector. Only after the recovery of remittance inflows in the beginning of the fiscal year 2011/12, the balance of payments started to be in the surplus, thereby easing the liquidity situation of the banking system. The inflow of remittance has been possible because of massive exodus of youth. Several media recently reported about 40000 workers leaving every month to Gulf States and other destinations. A large number go to India which is not often reported in the media. By any account, that is a substantial number. Although this trend has been easing a job crisis at home, it will have serious economic and social consequences. Yet foreign employment may not be a long-term solution for employment, and remittance inflows will not make economy productive and competitive. One obvious example of this is on rising pressure on wages because of such mass exodus of workers. There are many anecdotal stories of people having to pay much more even for a menial work. Moreover, import-based consumption supported by remittance cannot generate employment. More importantly, workers at lower-skill end, which constitute the bulk of our workers, are vulnerable to several other factors including long-term structural changes in the host country, rapidly changing technology, and the short-term nature of the work. To summarize, we are in a conundrum — while remittance is indispensible, we also suffer from its adverse effects.  Hence, our dependency on remittance can best be characterized as parasitical in nature. Unless we change we will be in no different position than a parasite which eventually dies when the host rejects it. Our policy makers better recognize the need to generate employment in the country and do all that is necessary to develop a healthy and sustainable economy. (Panday and Shrestha are PhD candidates at the American University, Washington DC, and The New School for Social Research, New York, respectively.)