Tracing the shifting patterns of remittance flows

Another set of international transactions—Indians sending money overseas—has already hit its record high. Under the RBI’s Liberalised Remittance Scheme (LRS), Indians can send up to $250,000 abroad a year for personal uses like travel, education or investment without prior permission. In 2022-23, flows to foreign countries under LRS were $27.1 billion.

LRS has been in the news after the government imposed a 20% tax on certain types of spending under the scheme, such as that on credit cards use overseas. After protests, the government tweaked the changes, by setting the tax only on overseas credit card spends of over ₹7 lakh a year.

Taken together, these two sets of transactions—bringing money into the country versus taking money out—provide a shifting picture over the years of how the behaviour of individuals or households, as opposed to those of corporations, have affected India’s balance of payments with the rest of the world. As this behaviour changes, it can introduce new uncertainties into India’s transactions with the rest of the world. In the past, the actions of Indians as individuals have made the country’s current account more stable, especially during a crisis, when other sources of flows, such as those from foreign investors have dried up. Will this work in future crises as well?

Degrees of Deficit

About 30 years ago, India implemented economic reforms. It was forced to do so, by a crisis in its external trade. In 1991, the foreign currency earned by India from exports of goods started falling dangerously short of foreign currency required to pay for imports—most importantly crude oil, whose price had soared due to the Gulf War.

But decades later, the original problem has not gone away. For 2022-23, India’s trade deficit (exports minus imports) was $267 billion. This was up almost 40% from a year earlier, again mainly due to the soaring price of oil, as a result of the Russia-Ukraine war. The trade deficit for the first nine months of 2022-23 had already exceeded 8.5% of GDP. This is well above the 1991 levels, which triggered a severe currency crisis.

But no such crisis has happened this time. This is partly because India has ample foreign exchange reserves to pay for any currency shortage. But also, a deeper, structural change has taken place in India’s ‘current account’. This comprises the trade in goods and so-called ‘invisibles’—the trade in services, and other ‘current’ transfers of foreign currency into India (essentially anything that is not a loan).

This trade in invisibles is what has been the real shift. It has enabled the country to withstand even fairly serious deficits in trade (Chart 1). Till the mid-1990s, the net income on ‘invisibles’ was around 1-2% of GDP. It gradually began creeping up, to its current level of 4-6% of GDP.

It was also at about the same time that the trade deficit (deficit on goods alone) started widening. Through the last decade, except for the covid year of 2020-21 and 2016-17, it has never fallen below 5.5%. If it had not been for the offsetting surplus on invisibles, India’s current account would have been in a far worse state than it is.

What comprises India’s invisibles trade? Almost from the beginning, there have been two main components: software/IT and business services exports, and remittances. In 2001, they together accounted for two-thirds of invisibles trade (in gross terms). By 2022-23, that combined share had increased to 75%. But what has also changed is the relative importance between those two components.

Remittance Cushion

Two shifts have occurred in the invisibles trade over the years. In 2001, remittances accounted for 45% of invisibles in gross terms, while revenues from software and business services accounted for 19%. Since then, software and business services exports have grown at a much faster pace and now account for 48% of invisibles. The share of remittances has fallen by 20 percentage points to 25%.

The composition of remittances has shifted as well. As the World Bank’s most recent report on remittances, issued last year, points out, “remittances have benefitted from a gradual structural shift in Indian migrants’ key destinations from largely low-skilled, informal employment in the Gulf Cooperation Council (GCC) countries to a dominant share of high-skilled jobs in high-income countries such as the United States, the United Kingdom, and East Asia."

An RBI study points to the fact that the share of remittances from the US, UK and Singapore increased to 36% of the total in 2020-21, up from 26% in 2016-17. Over the same period, the share of Middle East countries—Saudi Arabia, United Arab Emirates, Kuwait, Oman, and Qatar—dropped from 54% to 28%. Through the 2000s, and especially through the financial crisis, even as the importance of those two components of the invisibles account shifted in opposite directions, remittances continued to play a crucial role beyond just the headline numbers.

Meanwhile, official government data treats the entire so-called ‘private transfers’—money sent into India by private parties—as part of remittances. The direct remittances of workers to families are much less than this. However, overseas workers also deposit their earnings into non-resident accounts in Indian banks, for withdrawal by their families in India. These two components together account for 90-95% of total ‘private transfers’.

Remittances directly affect household consumption and income since they are transfers between workers abroad and their families back home, unmediated by any government in between. “Remittances are a vital source of household income for LMICs [low- and middle-income countries]," says the World Bank. “They alleviate poverty, improve nutritional outcomes, and are associated with increased birth weight and higher school enrolment rates for children in disadvantaged households. Studies show that remittances help recipient households to build resilience, for example through financing better housing and to cope with the losses in the aftermath of disasters."

Remittances are highly resilient to not just disasters but also economic crises. When the global financial crisis of 2008 hit, foreign portfolio flows to countries across the world dried up. But remittances, as a whole, continued to pour in. Between June 2008 and December 2009, for instance, net flows into India by foreign institutional investors (purchases minus sales of securities in India) amounted to $10.6 billion. Over the same period of time, when the global economy was in turmoil, a total of $71.6 billion in net remittances came in.

Net flows of revenue from software and business services during this period was $64 billion. The trade deficit for the two crisis years, 2008-09 and 2009-10, hovered at a whopping 9-10% of GDP. But the offsetting effect of invisibles meant that the current account deficit over this period remained well below 3% of GDP. Thus, it was migrant workers—many of them working in arduous, difficult and dangerous jobs like construction, with little job security—whose money transfers proved critical in protecting the Indian economy from being even more seriously disrupted by crisis than it actually was.

Spending Abroad

Under the LRS, introduced in 2004 with a limit of $25,000, Indians could take money out of India for travel, funding education, or investment, with no prior approval. Over successive stages, that limit was revised to $250,000 in 2015. Between then and 2022-23, annual outflows under the scheme went from $4.6 billion to $27.1 billion. About half the amount in 2022-23 was just for travel, another 15% was designated as maintenance of relatives and another 12% for studies abroad.

Taken together, worker remittances and the LRS provide a window into how individuals, as opposed to corporations or government, directly figure in India’s overseas transactions—one set brings money in, the other set takes funds out. If the government, the World Bank and others have made much of the fact that India is the world’s highest recipient of remittances, transactions going the other way have received relatively less attention (to be clear, there is nothing ‘wrong’ with Indians remitting funds abroad for travel or education). Assuming that worker remittances into India do cross $100 billion, LRS outward transfers could be as much as 27% of that amount, up from just 13% in 2016-17 (Chart 2).

Stabilization Factors

Remittances have proved to be critically important in shoring up India’s current account in the last couple of decades. In particular, this is the case during crises like the one in 2008, when foreign flows, especially those from FIIs, can suddenly dry up. But will they continue to do so in the future?

Of all the components that make up India’s economic numbers, external transactions on the balance of payments allow for the least control. India’s biggest imports are of crude oil, which is essential to keep the economy functioning, and is available at a price that is determined by global events and a global market. Like all fossil fuel economies, India has limited ability to reduce its fuel consumption in the short run, if prices skyrocket, without exacting a serious cost to normal economic functioning.

The other major change that has happened to India’s trade in the last two decades is China. India now runs a trade deficit with China that is comparable to what it runs with traditional crude suppliers. Thus, it is structural in nature in the sense that it may vary now and then with economic cycles, but only within a narrow range. These two groups, crude suppliers and China, together account for 90% of our trade deficit (though it is offset by surpluses with Europe and North America).

It’s an open question as to what will happen to remittance flows out of India by individuals (such as that under the LRS) at the time of the next crisis. Travel spending, which currently forms the bulk of LRS spending, will most likely go down, as it usually does at a time of uncertainty. But capital flight will likely increase when a crisis hits. The LRS is also one of the few direct policy levers the RBI has to immediately curb or ease flows—if the central bank wants, it can simply turn off the tap and lower the LRS limit.

Will remittances continue to play a stabilizing role during future crises? Even as the absolute volume of migrant remittances hits an all-time high, it has actually become less significant a factor in India’s overall current account, with revenues from software and business services now the dominant part of invisibles flow into India. Such trade flows are more cyclical. Thus, when the next crisis hits, remittance flows are likely to have a smaller effect on the health of the overall current account.

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