EXCHANGE RATE VARIATIONS AND MIGRANTS’ REMITTANCES TO NIGERIA: 1980 – 2010

ABSTRACT

This study examined  the relationship  between  exchange  rate variations  and migrants’  remittances  to Nigeria. The time-series econometric method of Vector Error Correction (VEC) was applied to estimate the demand–supply  equation  for  remittance  transfers.  An  empirical  model  that  links  remittances  to  its potential determinants was specified and estimated using multivariate Johansen co–integration test and complemented by impulse response and variance decomposition analyses.  The key result emanating from the study is that exchange rate variations have a significant  effect on remittance  transfers to Nigeria. Results also suggest existence of stable long run relationship between remittance transfers and its various determinants and a clear evidence of the positive significant influence of stable exchange rate on inflow of remittance to Nigeria economy. It further revealed that an appreciation of the exchange rate may lead to an  increase  in  transfers  and  improve  household  welfare  via  increase  in  household  consumption expenditure. Results also confirmeda bidirectional causal relationship between remittance transfers and exchange rates.Keywords: Exchange rate variations, migrants’ remittances, Vector Error Correction model, and Nigeria

CHAPTER ONE

INTRODUCTION

1.1     Background of the Study

International  economic  integration  in  the  early  21st   century  is  conventionally  thought  ofas increased openness to trade in goods and services, as well as a dramatic increase in the volume of capital flows. In recent years, many developing countries have witnessed significant increases in remittance flows, to the point that their scale has come to dwarf  that  of other types of capital flows (Adolfo,2010).  Remittances  are the international  financial  consequence  of immigration. They are an important source of external financing and foreign exchange for developing countries (Yang, 2006). Remittances are becoming increasingly important as a source of foreign income in terms of both magnitude and growth rate, exceeding the inflow of foreign aid and private capital in many countries. They currently represent one third of total financial flows to the developing world (Lartey, et. al. 2010).

Given the shortage of external financing in developing countries, these inflows are welcomed as a means of promoting investment and stimulating growth. International migrant remittances have increased significantlyover the last two decades. Remittances received by developing countries, estimated at $338 billion in 2008 and currently represent nearly 1.9% of total incomein emerging economies (Ratha, Mohapatra, and Silwal,2009). Flows of workers’ remittances appear to have been increasing sharply in magnitude during recent years. While related evidences suggest that most of this increase is real, it is not possible to assess its magnitude conclusively, because part of the increase in recorded flows may  simply reflect improved  recording systems.  Over the last decade, Egypt and Morocco have been the largest recipients on the continent and North Africa as a whole received more than 60 per cent of total transfers. In sub-Saharan Africa, Nigeria is the largest  recipient,  taking  between  30  and  60  per  cent  of  the  region’s  receipts.    However, economists believe that money sent home by Nigerians in various parts of the world now exceeds

$1.3 billion annually, ranking second only to oil exports as a source of foreign exchange earnings for the country(World Bank,2011).

Nigeria received $10 billion (about N1.5 trillion) from remittances, followed in a distant second positionby Sudan, with $3.2 billion; Kenya, $1.8 billion; Senegal, $1.2 billion; and South Africa,

$1 billion. The report also listed Nigeria among the top 10 emigration countries in the  region alongside  Burkina  Faso,  Zimbabwe,  Mozambique,  Côte  d’Ivoire,  Mali,  Sudan,  Eritrea,  the Democratic Republic of Congo, and South Africa. Remittances to developing countries proved to be a resilient source of external financing during the recent global financial crisis, with recorded flows rising to $325 billion by the end of 2011, up from $307 billion in 2009. The report added that remittance flows worldwide are expected to reach $440 billion by the end of this year (World Bank, 2011).Remittances  lead to more investments in  health, education, and small businesses. With  better  tracking  of  migration  and  remittance  trends,  policy  makers  can  make  informed decisions to protect and leverage this massive capital inflow, which is triple the size of official aid flows.   In line  with the World  Bank’s  outlook  for the global  economy,  remittance  flows to developing countries are expected to increase by 6.2 percent and 8.1 percent in 2011 and 2012 respectively,  with a projection  to  reach $374 billion by the end of 2012. The top remittance sending  countries  in  2009  were  the  United  States,  Saudi  Arabia,  Switzerland,  Russia,  and Germany.  Worldwide,  the  top  recipient  countries  in  2010  are  India,  China,  Mexico,  the Philippines, and France. As a share of GDP, however, remittances are more significant for smaller countries – more than 25 percent in some countries (World Bank, 2011).

Table 1.1Remittance transfers in different regions of the world

Regions/years	1970	1980	1990	2000	2009
Arab World	211,00	6403,25	11517,91	13219,00	35660,02
East Asia & Pacific (all income levels)	180,32	2309,49	7257,51	20189,72	97087,50
Europe   &   Central   Asia   (all income levels)	1387,80	19146,46	34462,18	52753,33	128848,03
Latin America & Caribbean (all income levels)	55,50	1933,28	5739,94	20359,76	56797,98
Middle East & North Africa (all income levels)	283,00	6532,63	12302,48	13520,47	35010,83
Sub-Saharan  Africa  (all income levels)	22,66	1399,39	1880,49	4636,83	20748,70

Source: WDI, www.worldbank.org.  Remittance flows (annual) in millions of current US$:(1970-2009)

Remittance flows in all the regions of the world have been on the increase, in some regions the rise has been substantial (see table 1.1 above). From year 2000 to 2009 the remittance  flows

increased almost 3 times in Arab world and Middle East and North Africa. In East Asia  and Pacific and Sub-Saharan Africa the transfers of remittance increased by almost 5 times. Europe andCentral Asia and Latin America and Caribbean regions the remittance flows increased almost

2.5 times from 2000 to 2009.

Particularly impressive is the growth of remittances in the past few years. This growth is closely associated with an increase in migration flows, widespread capital account liberalization and in particular,   the   technological   advancement   in  communications   that   facilitate   international monetary transfers. This is similar with the volatility of these financial flows. All these evidences suggest  that  different  monetary  and  exchange  arrangements  can  play  an  important  role  in countries prone to receiving remittances.   Remittances are unlike nearly all other capital flows which are stable and move counter  cyclically relative to the recipientcountry’s  economy. As a result, they mitigate the costs of forgone domestic monetary policy autonomy and also serve as an international  risk-sharing  mechanism  for  developing  countries.  Another  distinct  feature  of remittances  is  that  they  do  not  entail  the  creation  of  external  debt  with  future  repayment obligations.Unlike foreign development assistance, they do not come encumbered with a variety of political and economic conditions with which the recipient country must comply. The unique characteristics of remittances and their potential economic impact have attracted the attention of not only policymakers but also researchers in recent years, as evidenced by a growing literature aimed  at analyzing  remittances  and  their  consequences  for  individual  countries.  Three  main features of remittances provide the impetus for embarking on a  study  of their macroeconomic impacts, the size of these flows relative to the size of the recipient economies, the likelihood that these flows will continue unabated into the future through continued globalization trends, and the fact that these flows are quite distinct from those of official aid or private capital, which are much better understood in the literature. These features suggest that remittances’ macroeconomic effects are  likely  to  be  substantial  and  sustained  over  time  and  may  have  unique  implications  for policymakers in recipient countries.

The exchange rate is a key financial variable that affects decisions made by foreign  exchange investors,  exporters,  importers,  bankers,  businesses,  financial  institutions,  policymakers  and tourists in the developed as well as developing world. Exchange rate variations affect the value of international investment portfolios, competitiveness of exports and imports, value of international reserves, currency value of debt payments, and the cost to tourists in terms of the value of their currency.  Movements  in exchange  rates  thus  have  important  implications  for the economy’s business  cycle,  trade  and  capital  flows  and  are  therefore  crucial  to  understanding  financial developments and changes in economic policy. Timely forecasts of exchange rates can therefore

provide valuable information to decision makers and participants in the spheres of international finance, trade and policy making.

Undoubtedly, international migration can generate substantial welfare gains for migrants and their countries  of origin  as statistics  above  show  us.Worker  remittances  constitute  an  increasingly important mechanism for the transfer of resources from developed to developing countries, and remittances are the second-largest source(behind foreign direct investment) of external funding for developing countries. Contrary to earlier predictions  that  state that remittances would lose importance  over time due to declining  migration  rates (Macpherson,  1992), remittances  have actually grown more rapidly than international  migration flows. During the last three decades, streams of remittances to developing countries have been on the increase, it increased even more tremendously between 1970s and 1980s.

Apart from the significance of this magnitude in the countries of origin, remittances are generally less volatile, hence a more dependable source of funding than private capital inflows and foreign direct investment  (FDI) (Ratha, 2003; Buch and Kuckulenz,  2004).  Being unilateral transfers, they do not create any future liabilities such as debt servicing or profit transfers. Furthermore, remittances are argued to have a tendency to move counter cyclically with the GDP in recipient countries, as migrant workers are expected to increase  their support to family members during down cycles of economic activity back home so as  to help them in compensating for the loss family  income  due  to unemployment  or other  crisis-induced  reasons.  Whenever  true,  such a counter  cyclicality  enables  remittances  to  serve  as  a  stabilizer  that  helps  smooth  out  large fluctuation in the national income over different phases of business cycle. Yet, as shown by a considerable number of studies in the literature, the decision to remit is a complex phenomenon involving  other  factors  than  the  motivation  to  help  finance  current  (as  opposed  to  future) consumption spending of family members and relatives back  home ( Russell, 1986).

International price competitiveness, which is usually measured by the real exchange rate (RER) of a country,  has  an important  role  determining  export  performance  in economic  analysis.  The growth of tradable sector depends on the costs and prices of tradables, which in turn determines the demand for tradables domestically as well as internationally. The ability to reduce the cost of tradables, hence offering tradables at a lower price than its competing countries supplying exports in the world market,  not only attracts the foreign  buyers away from its competitors  but also increases the export volume and reduces the imports by lowering the price of import substitutes for the domestic  consumers.  This, in  turn, improves  the current account balance and adds to economic output and growth. Since price competitiveness  is one of the key factors that have a great influence on the export performance of a country, this study attempts to analyse the effect of remittances on the real exchange rate of Nigeria.

1.2 Statement of the Problem

The relationship between remittances flow and Real Exchange Rate is ambiguous since increased flow of remittances may impact differently on the Real Exchange Rates through  consumption, savings and investment choices by the recipient families on the economy. Inflow of remittances may increase the consumption by the recipient families on the non tradable sector, or reduce their work leisure  choice,  which may increase  the relative  price  of non-tradables  to tradables  and appreciate the real exchange rate of the country. On the other hand, the flow of remittances may increase the saving and investment  efforts by  recipient families,  lowers the resource  gap and raises investment in education, health and small businesses. This in turn will lower the relative price of non-tradables to tradables and improve the international competitiveness of the country. With remittances, an economy can spends more than it produces, imports more than itexports or invest more than it saves, and this might even be more relevant for small economies (Connell and Conway, 2000). On the other hand, remittances might perpetuate an economic dependency that undermines the prospects for development- recipients can become accustomed to the availability of these funds and there can develop a continuing trend of migration of working age population. One shortcoming of the existing literature on worker remittances is thus, that it mainly relies on microeconomic studies and, therefore, does not fully address the main questions of our current study.

There has been a growing debate on how the often voluminous migrant remittances are used and to what extent they contribute to the development of the migrant’s country of origin  (Obaseki,

1991; Obadan, 2004;Tomori and Adebiyi, 2007; Eke and Ubi, 2008; and Russell, 1986; World

Bank, 2008).

There  are surveys  on how remittance  recipients  spend  their income  and discussions  on  how effective government policies are in attracting remittances.

In fact, there is quite a literature, often negative, concerning the contribution of remittances to productiveconsumption    and   investment   (Todaro,1969;   Chami   et.   al,   2004;   Azam   and Gubert,2006; Lucas, 2004; Stahl, 1982).

Some research has found that the nominal exchange rate is a significant explanatory variable of migrant  remittances.  Lowell  (2005) found this to be the case with remittances  sent from the United States to Latin America and the Caribbean as did Lianos (1997) with remittances sent to Greece  from  immigrants  living  in Germany,  Belgium  and Sweden.  Lianos  found  that Greek migrants adjust their remittances to exchange rate changes so  that  the same value in terms of drachmas is sent back home (Lianos, 1997).Some other related studiesespecially in sub-Saharan Africa (Mongardini and Rayner, 2009; Onwusu-Sekyere et. al. 2011; Nwachukwu, 2008; Fielding

and Gibson, 2012)that have examined the relationship  between exchange rate and  remittances have focused mainly on how remittances have impacted the exchange rate and not exchange rate on remittances.

However, exchange rate in Nigeria might have a considerable impact on migrant remittances, and until we ascertainif it affects remittance or not we might not fully determine whether and how to regulate the exchange rate in order to enhance remittance.

Given the foregoing,  the questions are what are the relationships  between remittances  and  its determinants  especially  the exchange  rates in Nigeria?  Should  there  be deliberate  policies  to encourage or discourage the inflow of remittances in the country? In view of the unfolding reality coupled with protracted  debates,  this paper attempts  to critically examine  how exchange  rate variations  affects   remittances  in Nigeria  using econometric  modeling  and finally  to suggest appropriate policy strategies to improve on its inflow.

1.3 Research questions

In view of the above problems, the following research questions were raised:

i. Do variations in exchange rate affect remittance flows in Nigeria?

ii. What is the long run relationship between remittances and exchange rates in Nigeria?

iii. Is there any causal direction between exchange rate variations and remittances in Nigeria?

1.4 Objectives of the study

The main objective of the study is to find the influence of exchange rate variations on remittances into Nigeria.

Specifically, the study intends to:

i. Determine the trend analysis and response of remittance inflows to shocks induced by exchange rate variations inNigeria.

ii. Determine the long run relationship between remittances and exchange rates in Nigeria. iii. Determine the causality direction between exchange rates and remittances in Nigeria.

1.5 Research hypotheses

The following null hypotheses have been designed to guide the study:

H01:Remittance  inflows  are not influenced  by shocks  induced  by exchange  rate variations  in

Nigeria.

H02: There is no long-run relationship between remittances and exchange rates in Nigeria. H03: There is no causality direction between exchange rate and remittances in Nigeria.

1.6 Significance of the study

Empirical  works on this issue in Nigeria  is surprisingly  scarce, especially  in the light of  the voluminous literature that now exists on the estimation ofequilibrium real exchange rates. Despite the various roles that remittances receiptsplay in many developing countries and  their growing importance, the literature on the estimation of equilibrium real exchange rates has not typically incorporated  remittance  flows  into the set of real exchange  rate  fundamentals.  The  interface between remittances and exchange rates has been overlooked in the existing empirical literature by previous researchers in Nigeria. Therefore, the study has filled the gap evident in this area. Also, the study serves as a future guide to policy makers in the formulation of better and efficient policy options for managing  remittance  inflows  into  the country.  Most importantly,  itadds to existing literature on the above issue, thus providing relevant information that could guide further researchon the subject.

1.7 Scope of the study

This  study  focuses  on  investigating  the  effects  of  exchange  rate  variations  on  migrant’s remittances  in Nigeria. Hence, the study is based on Nigeria’s economy and  covers a sample period of 1980-2010. This range is chosen to ensure availability of data and for the analysis to be meaningful and to aid in the achievement of the objectives of the work.

1.8 Limitations of the Study

Although the research was carefully conducted, the findings in this report are subject to some  limitations, firstly the time frame was only limited from 1980 to 2010. It could have been extended beyond the study period, but for data availability  when the research  was started, hence the need for future researchers  to extend beyond the study period. Also, the study was based on Nigerian economy only, hence cannot be used to generalize for Africa, or for making global conclusions. This is also for future researchersto study beyond Nigerian economy.

1.9 Organisation of the Study

This  study  is  organized  into  five  chapters,Chapter  one  of  thestudy  which  is the  introduction, includes; the introduction, statement of the problem, the research questions, objectives of the study, research hypotheses,  the significance,  scope, limitations and  organization of the Study. Chapter twowhich   is  the  literature   review,   entails   the   conceptual   framework,   including   migrants’ remittances,  exchange  rate variations,  review  of exchange  rate  policy  in Nigeria,  overview  of exchange rate management in Nigeria, the theoretical literature, the empirical literature, summary of empirical  literature  and the  limitations  of previous  studies.  Chapter three, the methodology, comprises, the analytical and theoretical framework, model specifications and the justification of models specified, estimation technique and procedure, the co-integration tests, and data and their features.  Chapter four, which is data analysis and presentation of the results includes; the trend analysis,  analysis  of  empirical  results,  co-integration  test,  lag  selection  order  test,  variance decomposition  and  impulse  response  analysis  and  Granger  causality  test.  Chapter  five  is  the summary, conclusion and policy recommendations.

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