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The Impact of Capital and Foreign Exchange Flowson the Competitiveness of Developing Countries
Attracting capital and foreign exchange flows is crucial for developing countries. Yet, these flows could lead to real exchange rate appreciation and may thus have detrimental effects on competitiveness, jeopardizing exports and growth. This paper investigates this dilemma by comparing the impact of six types of capital and foreign exchange flows on real exchange rate behavior in a sample of 57 developing countries covering Africa, Europe, Asia, Latin America, and the Middle East. The results reveal that portfolio investments, foreign borrowing, aid, and income lead to real exchange rate appreciation, while remittances have disparate effects across regions. Foreign direct investments have no effect on the real exchange rate, contributing to resolve the above dilemma.
Workers’ Remittances and the Equilibrium Real Exchange Rate
This paper investigates the impact of workers’ remittances on equilibrium real exchange rates (ERER) in recipient economies. Using a small open economy model, it shows that standard "Dutch Disease" results of appreciation are substantially weakened or even overturned depending on: degree of openness; factor mobility between domestic sectors; counter cyclicality of remittances; the share of consumption in tradables; and the sensitivity of a country’s risk premium to remittance flows. Panel cointegration techniques on a large set of countries provide support for these analytical results, and show that ERER appreciation in response to sustained remittance flows tends to be quantitatively small.
The Impact of Remittances on Economic Activity: The Importance of Sectoral Linkages
We propose a simple macroeconomic model with input-output sectoral linkages based on Acemoglu et al. (2016) to quantify how changes in aggregate demand due to additional income from household’s remittances propagates through the network of input-output linkages in Sub-Saharan African countries. We first propose two network centrality measures to assess the role of some sectors as key input providers in the economy. Then, we use these measures to quantify the effect of sectoral linkages on sectoral and total output following an increase in remittances inflows. Our empirical results suggest that the effects of remittances on recipient economies increase with the degree of linkages across sectors, which is especially prominent in the case of the financial intermediation sector. Our paper contributes to the emerging macroeconomic literature on the propagation of shocks across sectors and the implications for the whole economy.
Taming Financial Development to Reduce Crises
This paper assesses whether and how financial development triggers the occurrence of banking crises. It builds on a database that includes financial development as well as financial access, depth and efficiency for almost 100 countries. Through estimation of a dynamic logit panel model, it appears that financial development, from an institutional dimension and to a lesser extent from a market dimension, triggers financial instability within a one- to two-year horizon. Additionally, whereas financial access is destabilizing for advanced countries, it is stabilizing for emerging and low income ones. Both results have important implications for macroprudential policies and financial regulations.
Macroprudential Policies, Economic Growth, and Banking Crises
Using a sample that covers more than 100 countries over the 2000-2017 period, we assess the impact of macroprudential policies on financial stability. In particular, we examine whether the activation of macroprudential policies is conducive to a lower incidence of systemic banking crises. Our empirical setup is designed to account for the potential direct and indirect effects that macroprudential policies can have on banking crises. We find that while macro-prudential policies exert a direct stabilizing effect, they also have an indirect destabilizing effect, which works through the depressing of economic growth. A Generalized Impulse Response Function analysis of a dynamic system composed of the probability of a banking crisis and economic growth reveals, however, that macroprudential policies have a positive net effect on financial stability (lower likelihood of systemic banking crises).
What Matters for Financial Development and Stability?
This study aims to identify policies that influence the development of financial institutions as measured across three dimensions: depth, efficiency, and stability. Applying the concept of the financial possibility frontier, developed by Beck & Feyen (2013) and formalized by Barajas et al (2013a), we determine key policy variables affecting the gap between actual levels of development and benchmarks predicted by structural variables. Our dynamic panel estimation shows that inflation, trade openness, institutional quality, and banking crises significantly affect financial development. Our analysis also helps identify potential complementarities and trade-offs for policy makers, based on the effect of the policy variables across the different dimensions of financial development.
Can Islamic Banking Increase Financial Inclusion?
The paper analyses existing country-level information on the relationship between the development of Islamic banking and financial inclusion. In Muslim countries—members of the Organization for Islamic Cooperation (OIC)—various indicators of financial inclusion tend to be lower, and the share of excluded individuals citing religious reasons for not using bank accounts is noticeably greater than in other countries; Islamic banking would therefore seem to be an effective avenue for financial inclusion. We found, however, that although physical access to financial services has grown more rapidly in the OIC countries, the use of these services has not increased as quickly. Moreover, regression analyis shows evidence of a positive link to credit to households and to firms for financing investment, but this empirical link remains tentative and relatively weak. The paper explores reasons that this might be the case and suggests several recommendations to enhance the ability of Islamic banking to promote financial inclusion.
Do Remittances Enhance Financial Inclusion in LMICs and in Fragile States?
This paper explores the relationship between remittances and financial inclusion for a sample of 187 countries over the period 2004-2015, using cross-country as well as dynamic panel GMM regressions. At low levels of remittances-to-GDP, these flows act as a substitute to formal financial channels, thereby reducing financial inclusion. In contrast, when remittance-to-GDP ratio is high, above 13% on average, they tend to complement formal access and usage channels, thus enhancing financial inclusion. This “U shaped” relationship highlights the role of remittance flows in financing household consumption at low levels, while raising formal household bank savings and allowing for more intermediation, at high levels of remittance-to-GDP.
