Blessing or curse: The stabilizing role of remittances compared with other financial flows

Abstract

Flows of remittances to Pakistan are being increasingly viewed as a relatively attractive source of external finance, which can help to foster development and manage economic shocks. Remittances have become a major source of revenue, surpassing the volume of foreign direct investment (FDI) and official development assistance (ODA) that the country receives. This study focuses primarily on the stability, cyclicality and stabilization impacts of remittances to Pakistan. It is evident that foreign flows exhibit different types of volatility; remittances are found to be a less volatile source of external finance than FDI and ODA; they are also found to be counter-cyclical and stabilizing, thus serving to stabilize the recipient economy in times of economic downturns. ODA appears to be a-cyclical and stabilizing, whereas FDI emerges as pro-cyclical and destabilizing. Furthermore, remittances are insensitive to cyclical fluctuations in the sending countries. We also consider a structural vector autoregressive (SVAR)-based identification in order to examine the responses of financial flows to innovation in receiving and sending economies. We confirm the counter-cyclical mechanism of remittances with respect to Pakistani output. In particular, our results indicate that remittance flows to Pakistan are mainly explained by the economic conditions in the country.