When Remittances Lift Incomes but Hurt Exports: The Crucial Role of Strong Financial Markets

Remittances boost household welfare but often appreciate exchange rates and weaken export competitiveness, especially in economies heavily dependent on them. The study finds that strong, well-developed financial markets can significantly cushion these Dutch disease effects by channeling remittances into savings and productive investment rather than consumption.

Remittances have become one of the most transformative financial forces in developing economies, and this working paper, produced jointly by the Asian Development Bank (ADB), the Policy Research Institute of Nepal, and the Nepal Rastra Bank, examines their complex relationship with exchange rates and national financial systems. Covering 146 economies from 1996 to 2021, the study explores a persistent macroeconomic contradiction: while remittances uplift households and stimulate demand, they often trigger real effective exchange rate (REER) appreciation, weakening export competitiveness. As global remittance flows have grown more than sixteen-fold since the early 1990s, this tension has become increasingly significant for low- and middle-income economies where remittances now outpace aid and sometimes even investment.

How Dutch Disease Creeps In

The study explains that remittances, though beneficial at the micro level, can disrupt macroeconomic balance. When inflows rise, households consume more non-tradable goods, pushing up domestic prices and causing REER appreciation. This appreciation makes a country’s exports more expensive and its imports cheaper, eroding external competitiveness. Over time, economic resources drift away from manufacturing and other tradable activities toward less productive sectors. The paper shows that this effect is especially pronounced in the 43 countries where remittances form a large share of GDP, places like Nepal, Tonga, Moldova, Haiti, and the Philippines. In these economies, remittances are not merely supplementary income; they shape national economic structure and labor markets.

The Buffering Power of Financial Markets

A central contribution of the study lies in its nuanced examination of financial development using the IMF’s broad financial development index. The authors find that the structure of a country’s financial system determines whether remittances become a stabilizing force or a source of currency overvaluation. Surprisingly, financial institutions such as banks tend to reinforce appreciation effects because they facilitate inflows and channel remittances into consumption. In contrast, financial markets, notably stock and bond markets, act as a powerful buffer. The interaction between remittances and financial market development is consistently negative and statistically significant: stronger markets redirect remittances into savings, investment vehicles, and cross-border assets, reducing pressure on non-tradables and moderating REER appreciation. This finding holds even under stringent instrumental variable tests using cumulative net migration and lagged remittances.

Regional Sensitivities and Inequality

The study’s regional breakdown reveals striking differences. South Asia, Sub-Saharan Africa, and Latin America are the most vulnerable to Dutch disease effects because remittances play an outsized role in household income, and financial markets tend to be less developed. In such regions, remittances flow more directly into consumption, fueling appreciation and undermining competitiveness. In contrast, economies with deeper financial ecosystems, such as those in parts of Europe and East Asia, experience weaker or inconsistent appreciating effects. Quantile regression results show that remittances exert their strongest influence on exchange rates in the lower and middle parts of the REER distribution. At the upper quantiles, extreme currency fluctuations are driven by trade fundamentals and external shocks rather than remittances.

Navigating the Dual Nature of Remittances

The paper closes by acknowledging the two-sided character of remittances. They reduce poverty, promote education and health investment, support financial inclusion, and stabilize household consumption during crises. Yet they can also distort macroeconomic fundamentals if funneled disproportionately into non-productive uses. To avoid this trap, the authors call for stronger domestic financial markets capable of absorbing remittance inflows more efficiently. They recommend deepening capital markets, improving regulatory frameworks, and expanding access to savings and investment instruments. High remittance-receiving countries should also design policies that channel remittances into productive sectors and export-oriented industries rather than consumption-heavy imports. Enhancing financial literacy, promoting diaspora investment vehicles, and supporting market-based financing can help transform remittances into engines of sustainable, long-term growth rather than sources of macroeconomic imbalance.