Remittance Economics How Currency Fluctuations Affect Families.

Published on: wapdat25.blogspot.com

Remittances from loved ones in foreign countries are not just additional income for millions of families in Africa and other developing areas, but also provide the financial means to cover food, school fees, healthcare, and housing costs. If the value of the currency changes, the real value of such transfers may fluctuate markedly and their impact on family budgets can be difficult for the donor to see.

Whether a sender or recipient, it is crucial to understand the effect of exchange rates on remittances in order to safeguard the purchasing power.

 The Basic Mechanics: How Exchange Rates Affect What Families Receive explores the impact of exchange rates on the money families receive.

The local family currency received by a migrant worker upon remittance will depend completely on the exchange rate on the day of the remittance. No matter how minor they may be, the repercussions could be quite severe.

Suppose someone sends money to a relative abroad at $500 USD per month and the exchange rate changes only 2% in favor of the relative, it could be an extra $10 USD worth of local currency, which is enough for some extra school supplies or groceries. However, if the 2% move is in favor of the recipient, the family is receiving less value for their hard-earned dollars.

The rates are constantly changing in response to changes in political activity, inflation, interest rate differentials and economic stability. These day-to-day changes can have a dramatic impact on families that rely on regular remittances.

 The "Strong Dollar Trap"

What is illustrative is that in the Philippines, as an example, billions of dollars are being sent home to relatives by OFWs every year. Remittance receipts will seem bigger in peso terms when the peso is weak against the dollar. But for many households, such gains of a few pesos are quickly eaten up by increased costs of food, fuel and electricity.

This was a sad story that one family in Nueva Ecija province shared. Their relative in New York sends them $500 to $1,000 per month, the same amount he did last year. Although the dollar to peso conversion rate is now higher due to the increased strength of the dollar, all this has been eroded by inflation.

Economist Sonny Africa of Ibon Foundation said the maths was simple: "If the family 'earns' P344 more due to peso depreciation, inflation will cost them P411 more for the same basket of goods".

This is the “strong dollar trap” (when the local currency is weak, there are more pesos to a dollar, but higher prices for imports and a declining purchasing power due to inflation that reduces the value of the dollar faster than the exchange rate benefit is realized).

 The True Cost of Food: A Hidden Story in the Price of Groceries.

Remittances directly lose purchasing power due to inflation. If a family receives $500 USD each month, then, with an annual rate of inflation of 5% in their country, the real value of the family's monthly income falls by approximately 5% over the course of the year. By December, a remittance that settled the entire bill for groceries in January might just have paid half of the expense.

This effect is magnified in countries which depend on imports. As the local currency depreciates against the dollar, imported food, fuel and manufactured goods rise in price, driving up inflation. A depreciating exchange rate and increases in inflation tend to work together in a vicious cycle.

 Transfer Fees and Exchange Rate Margins are considered Hidden Costs.

In addition to the headline exchange rate, families may also lose value due to transfer fees and exchange rate margins. There are two main means for a money transfer service to make a profit:

Transfer fees: These are the upfront fees charged from the amount being sent.

- The spread between the “mid-market” rate (the true exchange rate) and the rate that is being offered to the customer is the exchange rate margins

Despite a service claiming "zero fees", they can make up for it with an unfavourable exchange rate. This translates to less income for the family.

These are significant costs for regular senders who make remittances to families every month. If families compare providers and understand the amount of service they are getting, not just the fee, they will get a better value.

 Steps to safeguard the value of remittances

Families can do something about the purchasing power of the remittances:

Check the exchange rate prior to sending/receiving. When the local currency is stable, transferring prior to the crisis can prevent indirect losses. Some digital providers will supply rate alerts.

Consider low-fee options. Typically, digital money transfer companies charge lower cost rates than their conventional counterparts and have clear exchange rates.

Diversify receiving channels. Each of the three options, bank transfer, regulated digital platforms, and money orders, have varying exchange rates and fees.

Use some portion of the remittance for saving. Investing in inflation adjusted investments (term deposits or inflation adjusted investment funds) helps keep the purchasing power.

Plan recurring expenses. Families with regular remittances can help offset the need for immediate cash needs while preserving the value of their remittances over time by planning for expenses and gradually converting remittances to local currency.

This is the Bigger Picture: Remittances and Economic Vulnerability.

Economist Sonny Africa says that for families and governments, "the false sense of security" can be caused by a heavy dependence on remittances at the macroeconomic level. Remittances can provide short-term protection to families and the economy, but they can't replace the need for a stronger domestic agricultural and industrial base and high-paying local employment opportunities.

Remittances can also serve as a convenient pretext for governments to delay solutions to fundamental issues such as price increases, poor domestic economies, and excessive dependence on imports, critics note.

Among the ‘Big Four' economies in Africa (Nigeria, South Africa, Egypt, and Algeria), it has been revealed that remittance volatility increases the volatility of the exchange rate market for Sub-Saharan Africa (SSA) countries such as Nigeria and South Africa.

 The Bottom Line

When currency values change, the economic status of remittance-reliant families changes, too. A strong dollar leads to more local money, but inflation and an increase in import prices can more than offset that. There's an additional cut for transfer fees and exchange rate margins.

Before you can protect family budgets, it's important to understand these dynamics. Families can keep track of the rates, select the most affordable transfer channels and explore saving options to make sure every penny they send abroad is making a difference.

Has the exchange rate had an impact on your family's remittances? Write in the comments what you did.

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