By Matt Homer   

Apr 20, 2008

As the value of the dollar continues to decline relative to other currencies, some of those most affected don't even live in the United States. Instead, they are citizens of developing countries who receive remitted dollars from family and friends working abroad. For them, the weakening dollar is particularly crippling because it either converts into less local currency or, for those in countries with pegged currencies, can't keep up with local inflation.

It's a situation roughly similar to American travelers in Europe discovering that it now costs $4.77 for a Big Mac, whereas a year and a half ago the cost was only $3.77. The dollar is no longer going as far as it once did, and the decline is pinching the incomes of remittance recipients -- often the poorest -- and prompting shifts in international migration patterns. Policymakers in developing countries need to act soon to reduce the costs and unpredictability of remittances and ensure that social safety nets cover those who are harmed.

The most recent data show that in 2006 over $42.2 billion U.S. dollars were sent abroad. If this amount were the annual income of a country, it would be ranked just above Luxembourg as the world's 64th largest economy. What's more, the World Bank (which computes these statistics) says this estimate is most certainly low because it only includes "officially recorded remittances." The amount of money sent from the United States could be up to 50 percent higher: $63.3 billion.

For calculating the effect of a declining dollar on developing economies, the important statistic is not the absolute value of remittances, but the proportion of a country's GDP that they make up. For example, even though Mexico receives a larger number of remitted dollars from the United States than, say, Guatemala, the latter is more reliant on these remittances because they make up over 10 percent of the country's GDP.

Among countries that send most of their emigrants to the United States, at least 10 also rely on remitted income for more than 10 percent of their GDP. Most of the money that is sent home ends up in the hands of family and friends, who often are among the country's poorest (especially in Central America). Although there is a debate about whether or not remittances are an effective form of development aid, it's clear this money helps raise the living standards of those who need it most. Experts believe the majority of remitted money is used for daily purchases, but that at least some of it is also saved or invested. Compared with other forms of development aid, remittances benefit the poor more directly.

With the dollar's decline, countries where remittances have helped reduced poverty could see this trend level off or reverse.

Remittance recipients are further hurt by transaction fees, which can be more than 10 percent of the amount transferred. In addition to set fees, wire services such as Western Union often use a conversion rate weighed heavily in their favor. Because these services are the quickest and most convenient, and don't require as much documentation as banks, however, many migrants still use them.

The Philippines has been particularly challenged by the depreciation of the dollar. In 2006, remittances made up 13 percent of its GDP and this year the total value of remittances to the Philippines is estimated at $17 billion. The Philippines Congressional Planning and Budget Office estimates that approximately 40 million of its residents (that's nearly half the country's population) are supported by remittances sent home from at least 8 million Filipinos working abroad.

Since April of last year, the peso has appreciated against the dollar by over 13 percent and is expected to strengthen even further. The lower cost of U.S. imports to the Philippines has been of slight benefit against increasing food and energy costs. But at the same time money sent home from the United States by OFWs -- Overseas Filipino Workers -- is worth less. Monthly remittances to the Philippines decreased by approximately 8.6 billion pesos from January to December 2007.

In response, the Filipino government has been one of the most active in taking measures to ease the impact of the dollar's fall. To deal with this situation, the government has proposed two plans: "Peso Protect" and "Peso Insurance." The first of these is a government-sponsored forward exchange rate. OFWs agree to exchange dollars into Pesos at a specific time in the future at a pre-determined rate. While this option guards against further dollar declines, the risk for participants is that they will lose out if the exchange rate becomes more favorable. The second program is more flexible, but can also be more expensive. It gives OFWs the option to set a range of future exchange rates, but they the must pay an insurance premium that is determined by the rate they select. The more favorable the rate, the more expensive the premium.

The Philippines is also embracing technology as a way to drive down the cost of remittances. Specially equipped cell phones enable OFWs to remit money via text messaging. Although there are some associated costs, the fees are less than those charged by wire services and the exchange rate is closer to market rate.

In order to cope with the dollar's slide, migrants in the United States are also taking their own actions. Anecdotal evidence suggests many of them are working longer hours or taking additional jobs in order to send more money home. If the dollar declines further, more and more migrants will be tempted to return home or migrate to another country.

In fact, the Inter-American Development Bank has already recorded increases in euro-denominated remittances from the European Union to South and Central America, indicating some shifts in migration patterns are already under way.

Government in countries whose economies are significantly dependent on remittances would be wise to respond to the negative impacts of the falling dollar. First, it would be helpful if remittances were less costly. Ensuring that migrants have greater access to modern banking and financial institutions would be a good start. In addition, following the example of the Philippines in helping to guard remittance recipients against exchange rate fluctuations would help reduce unpredictability for migrants. Where it makes sense, governments may also consider bolstering social safety nets to protect individuals from lapsing into poverty when their income from remittances declines. Going forward, government efforts to promote greater savings and investment by remittance recipients would also help them weather bouts of reduced income and further development objectives. Long term solutions must also address factors that stimulate migration in the first place.

Short term efforts that create greater predictability in currency conversion and social programs that help those hurt the most won't change exchange rates or strengthen the dollar, but they will at least offer some immediate help for those who are remittance dependent to cope with an unexpected economic hardship.

Matt Homer is a program assistant at the Century Foundation, where he researches and writes about an assortment of international issues, including the rise of China and India, immigration, trade, and the global economy.

Source World Politics Review