In a period of decreasing reserves and foreign exchange shortages, migrant worker remittances had once been a welcome stream of income for Sri Lanka in fulfilling its foreign exchange shortfalls. With the recent sharp fall in remittances, the ongoing situation is causing chaos in the island nation’s mission to increase foreign exchange revenues. We will examine how remittances aided Sri Lanka in the past, the causes of the sudden drop, and most importantly, how we could keep remittances flowing as before.
“That’s a nice set of coloured pencils; where did you buy it?” This is not an uncommon question a Sri Lankan student would ask their classmate after noticing that they have a school accessory not commonly available in Sri Lanka. The friend explains that it wasn’t bought from a local shop but that it has instead been sent by a parent working abroad. Although it is a little conversation in school, it reveals a unique segment in the Sri Lankan economy.
Nearly 1.5 million of the country’s labour force, ranging from unskilled to skilled and professional, migrate to other areas of the world to gain employment. These workers frequently contact their families and send home part of their earnings and occasional goods. This foreign exchange component that they remit trickles into the larger economy and has been a vibrant component that balances out the island nation’s foreign exchange position with the rest of the world.
At a time when the external sector is confronted with daunting challenges such as depleting foreign exchange reserves and a stumbling dollar-rupee exchange rate, there has recently been a sharp drop in remittances, making the efforts to get on top of the country’s forex crunch an uphill battle. As of October 2021, Sri Lanka’s remittances receipts has dropped 14% compared with the respective period of 2020. This divergence has become increasingly acute in recent months, with inward remittances in September and October 2021 falling sharply to USD 353 and 317 million, respectively, the lowest levels for both months since 2010 and 2009. (Data sources: CBSL historical data and the provisional figures mentioned in the institution’s weekly reports; the November and December 2021 figures were not known at the time of writing this article)
Why is Remittances such an Important Component for Sri Lanka?
Before explaining the reasons behind the recent shortfall, a simple current account analysis, which summarises what countries spend and take in from abroad, provides a more comprehensive picture of the importance of this vital economic undercurrent.
The current account (CA) of countries like Sri Lanka can be written as CA = (X-M) + NI + NT. Where (X-M) is the trade deficit or the gap between the country’s exports and imports (of goods and services), NI denotes net income, and NT indicates net transfers where remittances are a part. Remittances have been a lifesaver for decades to fill the country’s persistent trade deficit and negative net income due to interest payments on foreign loans. Without this support, the country has to find other means, such as additional foreign borrowings, to fill the gap.
Figure 1 shows, excluding 2021 data, the flow of remittances has reached a tipping point in the mid-2000s and peaked around 2014, growing slowly since the 1990s. After this, it contributed roughly USD 7 billion per year from 2015 to 2020.
The figure also shows (X-M) plus NI and remittances as a percentage of (X-M) plus NI as separate series over the past two decades. One of the notable facts is that with the improved remittances flow, the widening trade deficit plus negative net income has been steadily supported by around 80% since 2014. Therefore, the recent remittances drop is a massive blow for the island nation, primarily in balancing its higher imports over exports (financing the deficit in the trade account).
What Happened in 2021?
The South Asian region is a good proxy for analysing Sri Lanka’s remittances dynamics in 2021 to determine if this is a regional issue. First and foremost, is the remittances drop a common issue in the region? The answer is not quite so. The World Bank expects the region’s remittances to grow by 8% in 2021 compared with the previous year, with key players India, Bangladesh, and Pakistan earning more than they did in 2020 .
By comparison, Sri Lanka’s most recent remittances dynamics seem quite different from this regional theme. As Figure 2 shows, since May 2021, there has been an apparent divergence from its remittances flows with the corresponding periods of the previous years, indicating that remittances have entered a rocky road. Some explanations suggest that the overvalued formal dollar-rupee exchange rate provides remittances with a lower value than the informal channels; hence, the remitters use informal channels such as the “Hawala” or “Undiyal” system provides them higher rates. (See e.g. Jayasinghe Reuters 6/12/2021). Those systems operate so that when workers hand over dollars to a middleman in their host country, the recipient in their home country can withdraw an equal amount of rupees through another agent. So, this causes those remittances to bypass and be unaccountable to the formal banking system, and sometimes they may not even be received in Sri Lanka.
Although this might be one of the reasons, the amount lost through the official channels appears to be greater than what studies reveal; for example, some studies show a 3% decrease from formal channels for a 10% rise in black market premium. Suggesting that there could be other reasons, such as official channel users have been restricting transfers in the belief that the rate differential in parallel markets is an implicit tax on them.
So, it seems there are two tasks that lie ahead to rectify the remittances flow:
- shifting informal channel users back to a formal banking channel
- encouraging those who might have used formal channels and limited remittances to send more.
The country’s ongoing actions, such as offering greater (premium) exchange rates to remitters and cracking down on illegitimate channels, seem to target shifting informal channel users back to a formal banking channel. However, it is important to remember that whenever there is a higher price for dollars outside the formal system, senders are likely to hunt for unclosed loopholes, reducing the effectiveness of the efforts.
As a result, these initiatives should be better paired with strategies that motivate workers themselves to use official channels and send more, rather than making them feel they should accept a lower price for their hard-earned money. To better design these policies, it is imperative that we find out what motivates them to send money.
What Other Factors Affect Remittances Flows?
Although an altruistic motive could be one reason migrant workers remit money, studies show (e.g. An Indian study by Jijin, Mishra, & Nithin (2021)) that it is an investment motive that motivates senders to remit money . Investment motive could be more pronounced among seasoned workers willing to shift their savings in bulk for investments or start businesses for the family. These flows are due to their overall confidence in the home country economy and its ease of doing business, including fewer restrictions and regulations imposed on their goals.
Over the past decade, Sri Lanka’s highest percentage increases in remittances, 24% and 25% occurred respectively in 2010 and 2011, following the boost in confidence in the economy after the end of the country’s 30 year-long civil war in 2009. This show how these flows are intertwined with better economic outlooks.
This idea is supported by Abbas, Masood, and Sakhawat (2017) in a Pakistan research study spanning 1972–2012, who show that financial, and political determinants and variables such as stable macroeconomic conditions influence increased remittance flows .
How to Best Manage the Remittances Flow?
Restoring remittances to previous levels is a critical challenge for Sri Lanka since it provides a lifeline to the economy in contrast to high-cost international borrowings. Studies show in most countries, the black market and the share of remittances flowing through it tend to feed each other; therefore, policies that bring remittances back to the formal channels would automatically shrink the black market as well.
Rather than predetermining the premium, authorities can identify the sender’s switching point between the informal and formal channels. From this, they can identify the level of relaxation on the exchange rate and the exact premium for remitters for a shorter period for effective absorption of the parallel markets.
Given the disadvantages of the black market, such as a lack of or no legal protection, a lack of transparency, and the possibility of scams, there is no need to offer a complete difference between the two markets to entice people to switch back. But, sufficient incentives need to be offered so that they do not feel they are penalised for using the formal channels.
In addition, since remittances are linked to investment intent, another front should encourage them to send more money home and through formal channels. It is important to build a network and boost their confidence by relaxing restrictions on them, providing investment opportunities and business guides for entrepreneurship, including credit and facilities to import machinery at concessional rates. Providing a robust safety net for their loved ones to help them out during the turbulent times of global economies is also essential. Overall, to help the country smooth out these flows, more diplomacy and a win-win situation for workers abroad seems to be the key in harnessing effective outcomes.
Finally, given the procyclicality (i.e. tendency to move alongside the economy’s cyclical condition) of remittances, the issue should not be isolated from the rest of the economy. Higher remittances are tied to better home-country economic conditions, so they are linked with policies that promote higher investment and export-led growth with subdued inflation that does not erode home-country investments. In particular, one important requirement is allowing the formal rate to reflect the real situation in the external sector by improving the overall macroeconomic situation with a business-friendly environment and consistent policies. That is the key to perfecting this mission.
The writer is a PhD candidate attached to Monash University, Australia. He would like to thank Mr C P A (Bindu) Karunatilake (a former Assistant Governor of the Central Bank of Sri Lanka) for commenting on the earlier draft of this article and helpful theoretical clarifications. The views and opinions expressed in this article are those of the writer, and he could be reached via firstname.lastname@example.org