Remittances and financial development in transition economies

Abstract

Because of their sheer size and remarkable growth in recent years, remittances to developing and transition economies have attracted the attention of policy-makers and scholars. One region in which remittances have been growing and having a significant impact on local economies is Central and Eastern Europe and the former Soviet Union. The paper uses data on remittance flows to twenty-seven countries of the former Communist bloc during 1996–2013 and three distinct empirical econometric approaches to study the impact of remittances on financial systems. In particular, the research focuses on the link between remittances and various types of credits and deposits, using dynamic system generalised method of moments estimators to address the issue of reverse causality and allow for dynamic effects. This issue is important for the region, as economic and finance theory documents the growth-enhancing and poverty-reducing effects of financial development. The paper provides evidence of a robust, significant, and positive link between remittances and financial development. The link is especially strong in the ex-Soviet Union and in the case of private credit. The contribution of the present research to the literature is threefold: it is the first study to focus on a relatively homogeneous set of transition countries; the region it addresses is of particular interest because financial development in the region had to start before full-fledged formation of a market economy’s financial institutions; and it applies novel, high-quality data on bilateral remittances from Russia to a subsample of transition countries in the former Soviet Union.