Mario Lettieri and Paolo Raimondi * –
Almost all of India’s neighbors, namely Pakistan, Sri Lanka, Bangladesh and Nepal, are facing balance-of-payments problems. Bangladesh is struggling to pay for its fuel imports due to a shortage of US dollars. Sri Lanka has already defaulted on its international commitments and Pakistan is on the verge of default. In addition to the commodity price shock, caused only in part by the war in Ukraine, the real trigger is due to exchange rate policies, both as a result of the monetary decisions of the Federal Reserve and those made by the countries in question. As is known, an increase in interest rates in the USA has the effect of devaluing the currencies of emerging countries and leads to capital flight.
The exchange rates of the Pakistani rupee, the Sri Lankan rupee (Slr) and the Bengali taka were kept fixed against the dollar for a long time. All three countries import fuel, food and fertilizers and, by resisting devaluation and maintaining a “strong” exchange rate, they have also kept the prices of imported goods low. At the same time, however, an artificially strong exchange rate makes exports uncompetitive and is not sustainable over time.
These countries have another export: human labor. South Asia (including India) is a major source of labor migration – some 43 of the 164 million migrants globally – and, consequently, a recipient of remittances. It is an issue that also affects Italy, since around 800,000 immigrant workers come from these regions. The World Bank estimates that 20% of the $815 billion in global remittances in 2023 will come from Asian citizens (excluding China) working overseas. It notes that in 2021 remittances, amounting to $157 billion, were three times foreign direct investment in that Asian region.
Incoming remittances have allowed South Asian countries to maintain “strong” exchange rates, against market realities. In fact, they have two exchange rates: an “official” one and a “market” one that reflects the devaluation. Workers who send money through banking channels must use the official rate. When the divergence between the two rates becomes too large, as it has for the past two years, remittances begin to decline. A large and sustained gap between the official and market exchange rates leads to the use of other informal channels for the transfer of money by workers.
The case of Sri Lanka is emblematic. In the second half of 2021, incoming remittances totaled $2.1 billion, down nearly 50% from the same period a year earlier. Sri Lanka has an outflow of over 1 million workers, many of whom have stopped using official channels, making default more likely. In early 2022, the official exchange rate was around Slr 200 to the dollar, while the market rate was more than 20 percent higher. Eventually, after the default, it takes 360 rupees to a dollar.
The Pakistani rupee, which fell more than 40% against the US dollar in 2022, is still trading on the open market at a significant discount to the official exchange rate. To preserve its meager foreign exchange reserves, Pakistan has cut imports, forcing some industries to shut down at the expense of its economy. Pakistani exports fell by 19% during the January-March 2023 quarter. Inbound remittances to Pakistan also took a hit. During the first 10 months of last year, remittances decreased by 13%. Foreign exchange reserves are running low and default is now a matter of time.
Bangladesh has taken corrective action as its monetary reserves started plummeting as early as 2022 but were still at a decent level of $35bn. He negotiated a recently approved bailout package with the IMF. Bangladesh had to devalue its currency by almost 25%. One of the factors that prompted the government to act was precisely the 16% drop in remittances.
In all of these cases, governments have been able to maintain an artificially strong exchange rate thanks to money flows from the millions of migrant workers. This policy is unsustainable in the long run. India is also a major recipient of remittances – $89 billion a year – but that is a fraction of its total exports. India abandoned fixed exchange rates in 1992 and allowed its currency to find its equilibrium. Its South Asian neighbors are much more difficult and are facing currency turmoil and renewed devaluations. It is one more reason to accelerate a more just multilateral world order also from an economic and social point of view.
* Mario Lettieri, former deputy and undersecretary for the Economy; Paolo Raimondi, economist and university professor.
