Effect of remittances on the macroeconomy: A Structural VAR study of Nepal

The paper examines the short-term macroeconomic impact of remittances using a case study of Nepal, one of the highest remittance-receiving countries in the world as a share of GDP. Despite the massive inflow of remittances during the turn of the century, the quantitative impact of remittances on the Nepali economy remains largely unexplored. Furthermore, macroeconomic modelling of the Nepali economy is at the infant stage primarily due to the unavailability of reliable data. Hence, using novel quarterly GDP data, this paper aims to fill both gaps by examining the effects of remittance and other macroeconomic variable shocks on the small open economy of Nepal between 2004 and 2019. Employing an SVAR model, the study finds that the impact of remittance shock on output (GDP) is not significant, but remittances significantly increased money supply and prices and appreciated the real exchange rate. These findings solve the price and exchange rate puzzles found in the earlier studies on Nepal. While foreign partners’ output primarily drives the remittance inflows to Nepal, the real exchange rate also plays a non-trivial role, but the domestic GDP or the interest rate do not appear to have a significant impact on the remittance inflows. Most of the macroeconomic variables do not respond to the policy rate; additionally, the reaction of money supply in response to a positive shock to inflation is not significant, which poses a further challenge to the policymakers in Nepal. Despite the monetary authorities in Nepal using money supply as the primary monetary policy tool, the transmission channel remains impaired.