Migrant remittances and real exchange rate dynamics in developing countries: Evidence of a U-shaped relationship

In this paper, we revisit the relationship between workers’ remittances and the real effective exchange rate. Using the NATREX equilibrium exchange rate framework for a small open economy, we establish the conditions for a non-linear relationship between remittances and the real exchange rate. Econometric estimates based on panel models with a threshold effect on a sample of 40 countries over the period 1980–2019 confirm a non-linear U-shaped relationship. For countries where remittances account for less than five percent of GDP, an increase in remittances results in a real depreciation of the exchange rate. This is reflected in improvement in external competitiveness, which can be attributed to the dominant supply effect stemming from capital accumulation. Conversely, for countries above this threshold, an increase in remittances leads to a real appreciation of the exchange rate, driven by rising domestic prices linked to a dominant demand effect. • We revisit the effects of workers’ remittances flows on the real exchange rate. • We obtain a U-shaped relationship between remittances and real exchange rate. • We find the threshold value of remittances-to-GDP ratio for the U-shaped curve. • The use of remittances, through demand and supply effects, explains the outcomes. • The relationship remittances-exchange rate depends on the level of financial development.