Do Remittances Promote Financial Development In Africa?

Abstract

Remittances to developing countries have become not only the second largest type of flows after foreign direct investments but have also become more than official aids received. This paper uses data on remittance flows to 50 developing countries in Africa from the period 1990 to 2011 in studying the link between remittances and financial sector developments, the extent to which remittances may promote financial developments and the causality traceable between remittances and financial developments in Africa. The study in particular examines the association between remittances and the aggregate level of credit to private sector, bank deposits intermediated by financial institutions and money supply in the developing countries, in this case, countries in Africa. This is an important gap considering the growth-enhancing and poverty-reducing effects of financial sector developments and immense growth of remittances received in the region over the years under study. The study uses the fixed effects, random effect estimations and Vector Error Correction Model method on the panel data in examining the link between remittances and financial development proxied separately by credit to private sector, bank deposits and money supply, all as a percentage of GDP. The study provides evidence of a positive significant link between remittances and financial developments in developing countries in Africa in the short run but tends to be negative in the long run. However, it is evidenced that financial development had a positive effect on the amount of remittances received in the long-run. Again, remittances caused financial development and so did the development of financial sector cause higher remittances in the short run. That is to say, remittances promote financial development to an extent as well as better financial system fostered the receipts of larger remittances, basically via formal channels. The effect of causality is well seen in both the long-run and the short run. The study then alludes to literature that remittances promote financial development and the development of the financial sector can help increase the propensity to remit.