Reasons for buying and selling foreign currencies: workers' remittances

International Trade and Globalisation – Foreign Exchange Rates

Objective

Understand the reasons for buying and selling foreign currencies, with a focus on workers' remittances.

1. What are Workers' Remittances?

Remittances are funds that migrant workers send back to their home country, usually to support family members. They are a major source of foreign currency inflow for many developing economies.

2. Why Do People Buy and Sell Foreign Currencies?

• Trade transactions – Importers need foreign currency to pay for goods, exporters receive foreign currency for sales abroad.
• Travel and tourism – Tourists exchange their home currency for the destination’s currency.
• Investment – Investors purchase foreign assets, requiring conversion into the foreign currency.
• Speculation – Traders buy or sell currencies to profit from expected changes in exchange rates.
• Workers' remittances – Migrant workers convert earnings into the currency of their home country to send money home.

3. How Remittances Influence Foreign Exchange Markets

When a migrant worker in Country A sends money to a relative in Country B, the following steps occur:

1. The worker exchanges the host‑country currency (e.g., USD) for the home‑country currency (e.g., PHP) at a bank or money‑transfer service.
2. The foreign exchange market records a sale of USD and a purchase of PHP.
3. The inflow of PHP increases the supply of foreign currency (USD) in the market, potentially affecting the exchange rate.

4. Impact on the Exchange Rate

Increased demand for the home‑country currency (from remittance inflows) can cause its value to appreciate. The magnitude of the change can be expressed as:

\$\% \text{ change in exchange rate} = \frac{\Delta E}{E_{0}} \times 100\$

where \(E_{0}\) is the original exchange rate (home‑currency per unit of foreign currency) and \(\Delta E\) is the change resulting from the remittance flow.

5. Example Calculation

Assume the exchange rate is 1 USD = 50 PHP. A remittance of USD 10 million is sent to the Philippines.

• Initial foreign‑currency supply: 10 million USD.
• After the remittance, the market receives an additional 10 million USD, increasing supply.

If the increased supply leads to a new rate of 1 USD = 48 PHP, the percentage change is:

\$\% \Delta E = \frac{48 - 50}{50} \times 100 = -4\%\$

The negative sign indicates a depreciation of the foreign currency (USD) relative to the PHP, i.e., the PHP has appreciated.

6. Benefits and Challenges for the Receiving Country

• Benefits

  • Increased household income and consumption.
  • Higher foreign‑exchange reserves, improving balance of payments.
  • Potential for investment in education, health, and small businesses.

• Challenges

  • Currency appreciation may reduce export competitiveness.
  • Dependence on remittances can make the economy vulnerable to external shocks.
  • Inflationary pressure if increased demand outpaces supply of goods.

7. Diagrammatic Representation

8. Summary Checklist