Impact of remittance flow on economic growth and poverty reduction in Nepal

Master's Thesis, 2015

77 Pages, Grade: Very good



1. Introduction

2. Theoretical Framework

3. Literature Review
3.1 Remittance and Growth
3.2 Remittance and Poverty Reduction

4. Background and Country Information
4.1 Economy and Poverty of Nepal

5. Methodology, Data and Results
5.1 Remittance and Poverty Reduction
5.2 Remittance and Growth
5.3 Regression of Remittance and Poverty Reduction
5.4 Regression of Remittance and Growth

6. Future Forecast
6.1 Remittance and Behaviour

7. Discussion
7.1 Positive Impacts
7.1.1 Micro Level
7.1.2 Macro Level
7.2 Negative Impact

8. Conclusion, Recommendation and Limitations

9. Bibliography

10. Appendix


This research uses time-series data to examine the impact of international remittance flow on economic growth and poverty reduction in Nepal. It applies the econometric model suggested by Ravallion (1997), Ravallion and Chen (1997) and Adam and Page (2005) for remittance and poverty and Quayyum et al (2008) for remittance and growth. Both micro and macro level impacts were considered. The regression results show that remittance flow is positively and significantly correlated with economic growth and poverty reduction in Nepalese context. The finding suggests that in the short run international remittance flow had positive contribution in economic growth and poverty reduction through investments in health, education and consumption. Remittance also contributed to relax credit constraints, especially for the poor and in macro level, helped to finance trade deficit, accumulate foreign exchange reserves and to reduce government debt. However, a deeper analysis of the last two decades shows that increased remittance flow has been the major cause of decline of tradable sector through ‘Dutch Disease’ effects. Moreover, remittance contributed to higher inflation, eroded work habits and brought adverse social costs. Combined, the long term impact of remittance seems to be overwhelmingly negative in Nepal.


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List of Tables

Table 1- Main Findings, remittances, poverty reduction and economic development

Table 2 – Sectorial structure of Nepalese GDP from 2000 to 2011 in Percentage

Table 3 – Economic indicators of Nepal

Table 4 – Trade scenario of Nepal

Table 5 – Relationship between GDP per capita and remitted amounts

Table 6 – Remittance and behaviour

1. Introduction

The portion of earnings that migrants send home by working in a foreign country is called Remittance (ILO). It has reached $ 550 billion (World Bank, 2013). Remittances sent through un-official means are not included in this figure but they are considered to be more than double the official size (Hulya, Thankom 2009). Official Development Assistance (ODA) to developing countries however remained at $ 134.8 billion in the same year (OECD, 2013) which is only one fourth of total remittance flow. Both ODA and remittances are seen as important tools to eradicate poverty however, ODA not always reach the neediest as the donors themselves have high fixed costs of their own and a substantial portion is lost in corruption (Collier & Gunning, 1999, Tavares, 2003). In contrast to ODA, remittances go directly to the households. That is why remittance flow is seen as a more effective tool to alleviate poverty and enhance economic development (Mendola, 2010). Remittance flow is expected to increase as the number of international migrants is increasing, up from 154 million in 1990 and 175 million in 2000 to 232 million in 2013 (UNFPA, 2014) comprising almost 4% of world population. The study of remittance and its wider effects has now been incorporated within the field of international migration (Campbell, 2010) and vast numbers of academic research are being done due to its immense importance in development.

Nepal is one of the top five recipients of remittances as a percentage of GDP. A total of $5.5 billion was sent to Nepal in 2013, comprising 25% of GDP (World Bank, 2013). The Nepalese economy is predominantly agricultural employing three fourth of the labour force producing 38% of the gross domestic product (CBS, 2011) with high unemployment which is why foreign employment is attractive for the youth. Remittance, after Agriculture is the second largest contributor to the economy (MoF, 2009). Figure 1 and 2 shows major recipients of Remittance both in number and percentage of GDP and the recent trend of Remittance, Aid and FDI flow to Nepal.

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Figure 1

(Source: Migration & Remittance Outlook,2013-15, Ratha, Timmer)

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Figure 2

(Source:World Bank Statistics, Economics ,2015, )

Before 1990, foreign employment was restricted except for British Army recruitment of Nepalese youth which started in 1816 after Anglo-Nepal war of 1814-16 (Lokshin et al, 2010). National and international migration increased after the democratic transition in 1990 and this trend escalated during the Maoist led civil war from 1996 to 2006 (Gartaula, 2009). The World Bank statistics shows that outward migration remained especially high after 2000 and crossed the threshold of 400,000 people per year in 2012. CBS,(2012) mentions that remittance receiving households has reached 56% and this will have a substantial effect for the family members left behind who can use the money for health, education, acquiring assets and save for the future. Various empirical studies of migration and remittances in regional level in Nepal has found that the benefits have been wide ranging for example increase of social capital, knowledge acquirement, education etc (Thieme, Wyss, 2005). However, there are also studies (like Sapkota, 2013) that found the detrimental effects of migration and remittance for example on agricultural yields. This shows that further migration and increasing remittance cannot be taken as win-win situation considering its negative consequences in some sectors. Hence, further research is necessary. The main goal of this paper is to evaluate the effects of migration and remittance flow on economic growth and poverty reduction in Nepal.

Number of research about migration and remittances concerning Nepal has been done in micro and macro level by individual researchers as well as national and international organisations. (Gartaula H.N 2009), (KC,B.K 2003) and (Shrestha B, 2008) studied the general impact of foreign employment and remittance on welfare and development in Nepal. There are several other studies regarding economic impact on regional level like Hoffmann T , (2001) in Solukhumbu district, Thieme S, Wyss (2005) on Sainik Basti, Nepal R (2012) in Eastern Nepal etc. Moreover, impact of remittance and migration on other fields and subjects were done, Niehof (2011) on the well-being of women, Maharjan A (2012), Sapkota et al (2013) on agriculture and agricultural yields, Subedi M (2009), Wagle U.R (2012) on socio-economic situation and Acharya, Leon-Gonzalez (2012) on poverty and inequality.

However, to my best knowledge, no study attempted to explore the impact of remittance on economic growth and poverty reduction using the data up to 2013. The most updated analysis is useful to shed light on this issue as international migration from Nepal increased rapidly in the past few years. The micro level studies of the past were limited in explaining the effect of remittances based on the findings. The unique contribution of this study is that it goes beyond the findings in a sense that it will attempt to explain why (even though remittance has positive impact in the present) remittances might impede growth in the long term and severely damage the foundation of the economy. Furthermore, the growth and poverty model used in this research has not been applied in Nepalese context. The integration of micro and macro variables to study the broader perspective is another distinctive feature of this study.

The research is structured as follows: Following the theoretical framework about international migration and remittance, literature review will present the major findings nationally and internationally. The findings are not limited to economic growth and poverty reduction rather on human capital as well because human capital is the major factor that affects growth and poverty in the longer term. Country information about Nepal will present descriptive information about the economy which is important to understand the reasons of migration and to forecast the future trends. The following empirical chapter will present the statistical findings about economic growth and poverty reduction with the interpretation of the findings. The results with broader impacts will be discussed. The discussion part will not be limited on the findings rather it will attempt to explain the trends and their impact on the economy in longer term. Finally, the concluding section will summarize the findings and gives some recommendations for the way forward and also talks about the limitations of this research.

2. Theoretical Framework

The main focus of this paper is on macro perspective of migration and remittance flow. The theoretical framework of macro perspective to remittance flow based on neo-classical economics of immigration was developed by Arthur Lewis (1954) and Harris & Todaro (1970) followed by ‘The New Economics of Labour Migration (NELM)’ by Stark and Bloom (1985) and Stark (1991). Additionally, the Network Theory by Massey and Esponia (1997), Munshi (2003) and Bohra and Massey (2009) and Human Capital Theory by Theodor Schultz (1961) is essential while explaining about the theory of labour migration due to significant inter-connectedness between them.

The Lewis (1954) and Haris & Todaro (1970) model presents several assumptions about migration. Even though the model was originally developed for internal (rural to urban) migration, it has international application i.e. it can be applied to international migration (de Haas, 2010). According to their theory, a geographical difference between two places is the fulcrum of migration. Countries with excess labour supply have lower wage rates whereas countries with lower labour supply ratio related to capital have higher wages. This wage differences between two places or nations will cause migration and the rate of migration tends towards zero when the wage difference approach to the equilibrium. However, some regional evidences shows, even in the absence of wage differentials migration takes place because people also migrate for other reasons than just earning wages (Katz, Stark 1986). The migratory tendency is different for high skilled workers than for unskilled ones as the former react to the rate of return of their human capital and is more likely to earn higher wages than those with lower level of human capital (de Haas,2008). Human Capital can be increased through investments in people for example in their education, skills and health which will derive increased economic benefits (Sweetland, 1996). Migration itself can also be seen as an investment (Sjaastad, 1962) since the migrants gain skills and experiences through ‘on the job training’, ‘learning by doing’ or further education.

The micro theoretical approach was taken from Massey et al (1993) which suggest that individual characteristic and skills like education level, experiences, training, language skills etc will increase the probability of migration, everything else being constant. Furthermore, individual characteristics, technology and other social conditions that reduce the cost of migration will enhance the returns hence encourage migration (Massey et al, 1993). In other words, networks and cultural ties to a foreign country are positively correlated with migration as the migrant provides information about the host country to non-migrant (Boyd 1989, de Haas, 2008) In contrast, if the migrant is not willing to help non-migrant, acting as “gatekeeper”, subsequent migration will not follow (Boecker, 1994, De Haas 2003 cited from De Haas 2010). The network and personal ties with migrants living abroad will cause further migration because it reduces transaction costs and lowers other risk (Massey et al 1993). Hence, potential migrants are reluctant to go to places where such networks do not exist and the likelihood to migrate will be higher in the presence of personal or societal networks. Social networks can be an important determinant of migration (Boyd 1989, Massey 1987, 1990, Brown 2002, Haug 2008, Zhao 2003). The Harris and Todaro (1970), Lewis (1954) model explains that labour market is the most important mechanism that causes the occurrence of international migration while others for example migration for educational and family re-union are of minor importance and both sending and receiving countries can control migration to the large extent by regulating their labour market.

The New Economics of Labour Migration (NELM) approach adds further dimensions in theory. The NELM highlights that the decision to migrate is not solely an individual action rather taken jointly by the family members as one unit under mutual understanding (Stark and Bloom 1985, Stark 1991). By this way, they diversify the risk of potential economic hardships by sending one or some family members abroad even if the wage is not necessarily higher. For people who lack an access to insurance and countries without proper risk management system, diversifying financial risk through international migration is necessary (Stark, Lehvari, 1982, Massey et al, 1993). Massey et al (1993) point few areas that are affected by migration namely insurance for crop failure, economic crisis and lending. Developing countries lack institutional mechanisms for risk management or they are not available for the poor. Crop failure for example is a serious matter and investment in crops is related to the income in the future which could be used to purchase other goods. Developing countries are prone to such natural disasters (Alcantara-Ayala, 2002). Families insure themselves by sending one family member abroad to remit. When local economic conditions deteriorate and unemployment level rise, it will impact the whole household and put them into risk. Hence, international flow of income would serve as an insurance against economic shocks (Massey et al 1993). Similarly, capital market hardly lends to the poor due to lacking collateral and money lenders charge a high interest on loans. For investment, capital is required. Remittance can work as collateral or can be invested itself.

Highlighted by (Lucas and Stark 1985), there are basically two reasons for sending remittances, altruism (which is again divided into pure altruism and tempered altruism) and self-interest. Hagen-Zanker and Spiegel (2007) add a third reason, ‘contractual agreement’ between family members and the migrant. The migrant is aware of the needs and hardship faced by family members left behind, hence sends remittances voluntarily without any selfish interest. Self-interest means sending remittances to acquire some assets or saving for the purpose of future investments in the home country (Nepal, 2012). Contractual agreement means a pre-determined arrangement between the migrant and family members left behind to fulfil the basic requirements which can include, repayment of initial migration cost and other costs that arise in the family like tuition fees of children, health expenses, and support during crop failure etc (Carling, 2008). Similarly, remittance will boost consumption and saving, increase the standard of living and can raise the productivity of family members (Pradhan et al, 2011). It also has income and distribution effects. Additional income would increase aggregate demand triggering a rise in production. When the recipient family choose not to participate in labour market, this will cause a rise of wages due to reduced supply of labour and this in turn will help workers of non-recipient families who participate in labour market. Furthermore, in the presence of flexible exchange rate system, there will be upward pressure for local currency due to remittances making the tradable sector less competitive but non-tradable sector might benefit (Orenius et al, 2009). On the other hand, remittance is unpredictable, increases dependency on imported goods if used mainly for consumption purposes and in some condition erodes work habits causing negative effects of migration (la Garza, Lowell, 2002) for family members left behind.

3. Literature Review

The general understanding of the sources of growth (hence poverty reduction) was limited to physical capital and technological change (Solow, 1956), investment in human capital (Schultz, 1980) (Lucas, 1988) (Barro, 1997), stock of ideas (Romer, 1986) (Jones, 2002) and external sources like FDI (Bjorvatn et al,2002) (Wang,2009) and Development Aid (Miniou & Reddy,2009) (Arndt & Jones, 2015). Since remittance has been perceived as one of the major sources that trigger economic growth, avenue of researchers were attracted to study it deeper. Large number of regional, national and international studies emerged and attempted to study the role of remittance not only on economic growth but also on poverty reduction (Goff,2010) (Imai et al,2012) human capital (Kugler,2005) (Salas,2014), inequality (Zhu,Luo,2008), consumption (Zarate-Hoyos, 2008) and agricultural yields (Sapkota,2013). Prior to 1975, number of international migrants remained low. Hence, remittance flow was insignificant. That is why only a handful of papers about migration and remittance flow were published. As the trend of migration increased after 1975 and is expected to increase further in the future, remittance will play an important role in economic development of developing countries. Either this role will be positive or negative will depend on various factors but since remittance can have multi-dimensional effects, a careful analysis of each of these factors is important.

3.1. Remittance and Growth

Large number of researchers have analysed the impact of migration and remittance flow on economic growth of remittance receiving countries. Internationally, the result is both mixed and ambiguous like the few studies done in Nepal. Dahal (2014) studied the impact of remittances on economic growth in Nepal analysing the effect in four major areas namely financial development, productivity, international trade and human capital accumulation. A positive association between remittance and financial development was found as ratio of bank deposits to GDP and ratio of bank credits to GDP both increased. Productivity was also positively associated with remittance. Although there was a decrease in manufacturing growth, the number of new businesses increased and the growth in non-farm activities (service sector) led overall productivity growth. International Trade and remittance had negative association in Nepal since the ratio of trade to GDP decreased while remittance to GDP continually increased. There was also positive association between human capital and remittance as the rate of school enrolment increased. His view was supported by Srivastav and Chaudhari (2007) who researched about the contribution of remittance in economic development of Nepal explicitly on gross domestic product, gross national income and per capita income. Their findings suggest that in micro term, there have been positive impacts such as increases in savings, investments in health and education whose outcome will be long lasting whereas there is no durable impact on real income because saving more remittance income itself will not generate income, it should also be invested meaningfully. The results show that only in short term, remittance growth is correlated to significant GDP growth. The authors recommend from their findings that in order to generate desired outcome sustainably in macro terms, ensuring a better use of remittance is vital. Both studies hint the incidence of ‘Dutch Disease’ in Nepal. Remittance can cause currency appreciation, raise production cost through rising wages due to less availability of raw labour which can lead to reduced competitiveness, hence a decline of production sector ( Acosta et al,2008), (Amuedo-Dorantes, 2004). A study by Gupta, Patillo and Wagh (2007) has found this phenomenon in sub-Saharan Africa and Fajnzylber & Lopez,(2007) found the extent of this, namely, when remittance as percentage of GDP doubles, exchange rate can appreciate by up to 24%.

In neighbouring Pakistan, Qayyum et al (2008) studied the impact of remittance on economic growth using the data of 1973-2007 and found a positive and significant effect. Remittance enhanced development in Pakistan and had considerable effect on poverty reduction. These findings were supported by Dilshad (2013) who studied the impact in Pakistan using the time series data from 1991 to 2012. However, the evidence in three other neighbouring states, India, Bangladesh and Sri Lanka is mixed. Study done by Siddique et al (2010) found, in Sri Lanka, two-way causality was observable between economic growth and remittance implying that both affect each other, remittance was positively associated with growth. However, in Bangladesh and India such relationship was not found i.e. growth in remittance flow did not lead to economic growth. De Haas (2007) concludes that remittance protect people from sudden income shocks, contributes to enable people to improve their lives through better living conditions, health, education etc. Remittance also loosens the credit constraints and in macro level, supports the national economy.

Under what condition the effect of remittance on economic growth will be positive has been the matter of intense debate and research. Azam and Khan (2011) after analysing the effect on economic growth in Armenia and Azerbaijan between 1995 and 2010, which was significantly positive there, mention that the key to positive impact is the better and efficient use of remittance. A mere consumption would not generate positive result in the long term whereas investment probably would. This view was supported by Ekanayake and Mihalis (2008) who found positive and significant relationship between growth and remittance flow analysing the panel data of developing countries from 1980-2006 considering regional differences and highlighted that the relationship between remittance and growth is more likely to be positive under certain conditions like stable macroeconomic environment, export-oriented economic policy and better human resources.

Developing countries in general face financial constraints and other challenges to maintain a stable macroeconomic environment. Remittance can relax the financial constraint so that the positive impact could be realised. Ratha et al (2010) found that remittances boosts foreign currency reserve and improves external debt and balance of payments which can strengthen country position in international capital markets. Furthermore, remittance increase during economic crisis in home country (Kapur, 2003) (Ratha, 2007) acting as a stabilizing force to help to avoid any macroeconomic shocks. Hence, the positive role of remittance on stabilising macroeconomic indicators and better investment for example in human capital would positively affect economic growth. However, it is not obvious.

3.2. Remittance and Poverty Reduction

Avenue of literature has studied the impact of remittance flow on poverty with positive results. Remittances have largely contributed to reduce poverty although it has also increased inequality (Portes, 2009). Lokshin et al (2007) studied the work related migration and poverty reduction in Nepal between 1995 and 2003 and concluded that almost one fifth of poverty reduction between the studied year could be attributed to migration and remittance flow to Nepal. Without migration, the number of poor household would increase, the mean per capita expenditure would decrease and the living standard would be lower. The authors have forecasted correctly that migration and remittance flow would gain importance in the coming years due to the increased volume hence help to reduce poverty further. According to World Bank (2012), ‘one third to one half of poverty reduction in Nepal can be attributed to remittances’. Another IMF study of 101 countries from 1970-2003 found a strong link between remittance flow and poverty reduction in both poverty headcount ratio and poverty gap (World Economic Outlook,2005,p-76). Similar results were found by IFAD study of 14 countries in Asia-Pacific region 1980-2009, that remittance flow has promoted economic growth and reduced poverty through direct effects (IFAD, 2012). Adams and Page (2005) studied the impact of remittance and migration on poverty in 71 developing countries. Their results showed that remittance and migration significantly reduce the poverty in developing countries in terms of ‘level, depth and severity’. The data showed that 10% increase in remittances will drop the portion of people living in poverty by 3.5%. Banga and Sahu (2013) found that remittance reduce poverty significantly. However, the extent is higher in countries where remittances exceed 5% of GDP. The Remittance Matrix of World Bank (2013) shows that there are 17 countries in the world where Remittance consist of more than 5% of real GDP. These countries are all developing countries including Nepal. The authors highlight that the flow of remittances should take place regularly to have a positive and sustainable impact on poverty reduction.

Since poverty is linked with education, health, nutrition and other exogenous factors, it is also important to see how remittance impact education level, health status or consumption. Table 1 below summarizes the main findings of literatures that attempted to see the relationship between remittances with poverty reduction, economic development and the areas that are closely related with it:

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Table 1 (Source: Accumulated by the author)

4. Background and Country Information:

Nepal is sandwiched between India and China. The population of 29 million live in a total area of 147,181 square kilometres. High degree of centralization has left the large rural parts under-developed and the resources untapped. As a result, rural emigration is high and the cities face massive population pressure bringing the infrastructures like health services, water supply and other public services into a near break-down. International migratory trend started after 1990 and increased rapidly after 2000. As rural dwellers started to get wealthy through remittance flow, rural to urban migration increased even further. Causes of emigration are mainly poverty, unemployment, political instability and violence (Gautam, 2005, Sherpa, 2010). Figure 3 shows the number of Nepalese in given countries.

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Figure 3

Source: (Computed by the author from World Bank Migration Matrix, 2013)

4.1. Economy and Poverty of Nepal

With a nominal GDP of $19.2 billion and per capita income of $694 (World Bank, 2013), Nepal is one of the poorest countries in the world. One quarter of the population live below the national poverty line and 17% live with less than one dollar a day. About 70% of the workforce is subsistence farmers but agriculture comprise of only 35% of GDP whereas industry and service sector comprise 20% and 45% respectively (CBS, 2013). After democratic transition and economic liberalisation in 1990, service sector rose slightly but are concentrated mainly in urban areas. The composition of economy in terms of primary, secondary and tertiary sectors is presented in Table 2:

Sectorial Structure of Nepalese GDP from 2000 to 2011(%)

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Table 2 (Source: Structure of Nepalese GDP, Ministry of Finance, 2011)

Nepal exports only to handful of countries, mainly raw materials, carpets and tea and major imports are machinery equipment, petroleum products, iron, chemicals etc (WTO, 2014). Trade deficit is increasing, at the same time industries and industrial production is decreasing. Table 4 shows that within five years, import export ratio has increased from almost 2:1 to 6:1. Major import partners are India, China, United Arab Emirates, South Korea and Japan whereas major export partners are India, Bangladesh, Germany, UK and USA (Mof, Economic Survey, 2012). Table 3 summarizes major economic indicators:

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Table 3 (Source: World Bank Statistics, Economics 2014 )

Nominal GDP and GDP per capita more than tripled in 13 years with inflation averaging at 6.80%. Population increased by almost one fifth during the time. Economic growth enabled better public services and impact on health, education and other sectors. Figure 4 and 5 summarize the progress.


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Impact of remittance flow on economic growth and poverty reduction in Nepal
University of Glasgow  (Adam Smith Business School)
Master of Science in Economic Development
Very good
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Auslandsüberweisung, Entwicklungshilfe, Remittance, economic growth, poverty, poverty reduction, nepal, migration, international development
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Bikal Dhungel (Author), 2015, Impact of remittance flow on economic growth and poverty reduction in Nepal, Munich, GRIN Verlag,


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