Role of Remittances in Financial Market Development in The Countries of The Gulf Cooperation Council - Thesis Proposal Example

?Introduction Gulf Cooperation Council or GCC is an economic and Political union of Arab s which border with each other in the Persian Gulf. Major countries of this region include Bahrain, Kuwait, Saudi Arabia, Oman, Qatar and UAE . It has its own common market and a monetary council and is also moving towards a shared currency in some countries of the Region. One of the key characteristics of this region is the fact that the region is rich with oil resources and is the major supplier of oil to the world. Despite oil wealth, however, the financial markets in these countries and especially in Jordon have not been as satisfactory as it should have been. Due to its peculiar characteristics, this region also holds large number of expatriates and is also the center of large remittances being sent to expat countries. Such large amount of remittances sent through both the formal as well as informal channels has been a regular feature of the economies of these countries. The literature on the role of remittances and the financial market development clearly establish a link between the two. It has been suggested that financial market development results into lower transaction costs for sending remittances besides can also improve the competition between the institutions involved in international money transfer and other related services. It also improves the process of financial market development within any country or region. This research will focus upon exploring and understanding the link between remittances and financial market development in GCC region. Aims of the Study Developed and well balanced economies tend to have better integrated and developed financial markets. It is often difficult to assume that any country will be able to achieve economic growth without having significant improvements in the development process of its financial markets. GCC region is an oil rich region and its financial market development is necessary for its development and growth in long run. It is making development towards strengthening its financial markets by implementing common currency, monetary union as well as integration of its stock exchanges. The overall aim of this study therefore is to understand as to how the overall financial development process has been undertaken by the GCC countries and whether consistent and increased remittances outflow from these countries effectively contribute towards the financial development of the region. More specifically, this research aims to achieve following objectives: 1. To evaluate the overall process of financial market development in the GCC region. 2. Dependence of financial market development process on oil & other resources 3. Dependence of financial market development on the remittances. 4. How remittances can improve the financial development process within the region. The overall objective therefore is to comprehensively understand the process of financial market development, how oil resources are supporting it and what role remittances can play to strengthen and quicken the process of financial development within the region. This research study will also undertake a systematic historical review of the financial market development process also. Literature Review This literature review is divided into three parts i.e. first part will discuss the relationship between financial markets and economic growth, second part will explore the relationships between financial market development and remittances and finally a review of financial market development process in GCC will be discussed. Most of the existing literature on the topic is focused upon understanding the impact of remittances on the recipient countries however; very little emphasis has been placed on the impact on the host countries. Though literature have comprehensively covered the impact of immigrants on the host countries macroeconomic environment however, how the immigrant remittances are going to affect the macro-economy as well as financial market development still need to be explored in systematic and cogent manner. Financial markets are considered as one of the most important components of an overall economic system of any country. Financial market development and the economic growth of any country has a positive correlation and therefore the development of financial markets is considered as essential in order to achieve consistent economic growth in longer run. (Johnson 1984 ). It has been argued that in certain times, developed financial markets actually allow innovation in technology and economic organization to happen. This tendency of the financial markets to actually support and fund innovation and technology actually improves the economic growth. It is critical to note that the financial market development process can be split into two broader levels of factors which affect the overall process. First are the broader macroeconomic level factors which affect the financial market development and secondly, the institutional factors which actually outline the role of supervisory and regulatory institutions in strengthening the process of financial development. It is critical to note that both the factors are considered as interrelated as the macroeconomic factors tend to support the development of stronger regulatory and supervisory institutions which itself result into the enhancement of financial market development process within any given economy. On the macroeconomic level, strong correlation has been observed between different macroeconomic variables and financial market development. Macroeconomic variables such as income levels, per capita income, inflation as well as economic openness tend to have a direct influence on the financial market development process. Per capita income is considered as the best indicator of the readiness of the financial markets to develop and is also an strong indicator of the measure of the financial market development process. Studies have found significant correlation between domestic investment levels, growth level of income as well as financial intermediary development as key macroeconomic variables which tend to have a direct influence over the financial market development process. (Castillo-Ponce,Hugo & , Manzanares-Rivera, 2011) Studies conducted with specific reference to the developing markets also tend to suggest that financial liberalization as well as foreign portfolio investment policies have correlation with the economic development process. Developing countries, in order to achieve financial market development must re-orient their financial policies and make them more liberal in order to start the process of financial market development. Financial markets tend to get stimulated with the financial policies which are relatively liberal in nature. (Masoud, & Hardaker, 2012) Studies have also linked inflation with the financial markets development as higher level of inflation tends to impact financial markets. Higher level of inflation create less liquid and smaller financial markets as financial markets shy away from investing larger portions of their capital due to rapid erosion. Private credit and equity markets specifically become more risk averse where high inflation rates exist. Some studies even indicated a non-linear relationship between financial market development and inflation as after reaching a certain threshold level of inflation, financial markets experience abrupt dips into their performance. This non-linear relationship may therefore indicate that in high inflation environment financial institution’s performance may rapidly decline and their traditional role in economy may also minimize. Openness of the economies is also one of the critical macroeconomic factors contributing towards the financial market development. Openness of economies tends to bolster domestic capital markets and help them to evolve rapidly if financial liberalization policies are adapted. Existing literature however has divided economic openness into two components of capital and trade openness however; major work has been done to assess the correlation between capital openness with that of the financial market development. Studies have also explored the assumption of whether the simultaneous openness of both the capital as well as trade is necessary for the financial market development. Studies so far have shown conflicting results and argue that it may not be entirely necessary to have both capital as well as trade openness for the financial market development. Institutional factors also tend to play an important role in the development of financial markets as properly enforced property rights, investor rights, control on corruption as well as contract enforcement are some of the factors which can result into financial market development. Research studies have specifically outlined the role of contract enforcement as one of the leading institutional factors to result into financial market development. Role of Remittances in Financial Market Development During recent decades, Remittances have formed one of the significant portions of the international capital flows. Financial liberalization has resulted into better capital flows with expat easily sending funds to their home countries. It is critical to understand that for developing countries especially remittances form a significant part of the international capital flows and is also one of the most important sources of foreign exchange for developing countries. Remittances are considered as private flows which are mostly spent either on consumption or investment. Major part of the remittances is spent on the consumption therefore remittances are critically different from other sources because they are hardly used for the investment purposes. This nature of remittances therefore make them relatively a less attractive factor for stimulating investment within the economy as households receiving remittances do not spend it on making larger investments. (Connell, & Burgess, 2009) Various studies have actually outlined the overall responsiveness of the financial intermediaries towards the remittances as important for financial market development. The propensity to remit increases when financial intermediaries are willing to respond to the changes taking place in the market and facilitate the process of remittances. There is a large body of evidence suggesting the role of financial intermediation in the economic and financial market development. Efficient and cost effective intermediation process can improve the functioning of the financial markets hence if financial intermediaries can offer flexible and rational remittance support; remittances can result into effective financial market development process. Various studies have also outlined the impact of migrant remittances on the size as well as the efficiency of the financial markets. (Maimbo, 2005. ) In order to increase the propensity to consume, it is critical to actually increase the competitiveness of the financial services firms offering remittance services. Lower transaction costs can actually increase the liquidity for the financial firms as it will offer induced incentives for remitters to actually remit through formal channels. Higher level of remittances therefore allows financial institutions to have access to larger portion of household deposits and thus can redistribute them to other components of the financial system to accelerate the development process of financial markets. There has also been growing emphasis on the development of innovative financial products which can add to the overall remittance process. A well developed and mature financial market can produce innovative financial products and services which can specifically cater to the needs of remitters. Technology is also considered as one of the effective factors behind the financial market development and the remittances. In order to process remittances effectively and become more flexible, financial markets tend to adapt to more sophisticated technology. Speed and accuracy with which remittances can be sent depend largely upon which technology is used by the financial institutions. Developed financial markets tend to be open in adapting new technologies to reduce the transactions costs and become more effective in inducing higher propensity to remit through formal channels. It is also important to note that the appreciation of the host country’s currency tend to have influence on the foreign exchange rates. Financial institutions dealing in the foreign exchange market therefore have to develop risk hedge products in order to hedge themselves against outflows. Outward remittances tend to increase with appreciation of the host country’s currency therefore financial markets need to develop the capacity to absorb such volatility in the foreign exchange rates of domestic country. Financial Market Development in GCC Countries GCC is considered as one of the fastest growing capital markets in the world and its financial services sector is considered is going through an extensive overhaul to make it competitive at global level. On the whole, new trends are being witnessed in this region as young population is growing with more educated individuals forming major chunk of the population. These trends therefore are indicating to financial markets to respond to the new trends emerging in the market to cater to these diverse needs. Overall bond market in the country is still developing with Islamic fixed income securities also flourishing along with the traditional bonds. Though the bond market shrunk in 2010 however, it rebounded in 2011 and 2012 is considered as a healthy year for bond markets.1 Bonds Market in 2011 increased by 19% as compared to 2010 showing healthy signs of recovery. The current global crisis has very little impact on the GCC countries as stronger counter-cyclical policies along with stronger reserves accumulated during oil boom of 2003-2008 has actually helped GCC countries to minimize the impact of global crisis. Source: http://www.imf.org/external/np/vc/2010/033010.htm GCC region comprises of less than 15% population of the overall Arabic speaking region however, it is also the wealthiest part of the Arab world. The presence of oil resources have made this region as one of the richest regions with oil flows amounting to Billions of dollars every year. Due to this factor, it is also the hub of the international expatriate activity as many expats from South Asian and other countries migrate to GCC countries in search of better paying jobs and potential to achieve higher living standards.( Billmeier.& Massa1, 2007. ) Due to dominance of oil in the overall GDP of the region, stock market capitalization has also been captured by the oil sector. More than 90% of the stock market capitalization is based upon oil related stocks thus suggesting that the overall development of the financial markets in GCC region is largely dependent upon oil related stocks.( Gangopadhyay, & Elafif 2011) Studies have indicated that the long term survival of the financial institutions and macroeconomic stability in the region is largely dependent upon the economic diversification of the region. Financial markets cannot be developed if they continue to rely on one sector for its development therefore the true financial market development can only be achieved if economy of the region is diversified.( Bacha, 2008) It is also important to note that with the less reliance of government on borrowing, the market for government securities have not been fully developed in the region. With fixed exchange rates, the government securities as well as the foreign exchange market is considered as thin across the region. This lack of impetus from the two of the major components of the financial markets system may slow down the overall progress of the GCC countries to expedite the process of financial market development. (Magableh, Athamneh, & Almahrouq, 2010) It has also been suggested that the development of flexible payment mechanism across the whole region may also be necessitated. To help remittances to actually improve the competitiveness of the financial institutions in the region, it is important that the flexible payment mechanism must be developed. In the absence of any such mechanism, it may be relatively difficult for countries to accelerate the process of financial market development.( Edgett, & Parkinson,1994,) Considering the overall complexity and needs of the region, it has been argued that GCC requires much sophisticated financial system and products to help develop its markets. The lack of market sophistication may slow down the overall process of financial market development. This is particularly more critical due to the fact that non-cash transactions are on the rise. The development of non-cash payment mechanism is mainly due to the fact that wealth in GCC countries is either held in the form of US dollars or Gold and not in the local currency. Due to this fact, not only foreign exchange market of the country has suffered in terms of overall development but has also slow down the progress of market development. (Neaime 2005) Remittances are one of the largest parts of the overall volume of transactions taking place in the GCC region. With more expats coming to the region, its ratio may further increase in future therefore the lack of sophistication in the financial markets may discourage remitters to use formal channels to make remittances thus making financial markets less reliant on external sources of liquidity. Remittances can result into improvements in the financial markets and contribute towards its development especially in terms of reducing the transaction cost as well as increasing the sophistication of the whole system. The innovation in product development can allow host countries to develop sophisticated and flexible payment mechanism to facilitate the payments across the region and to other countries also. Methodology Methodology is considered as systematic review and investigation of the research topic through various methods. It basically outlines as to what is achievable by the researcher to understand how accurate and credible their research claims can be. In order to perform this research study, researcher will use a mix of both the desktop and primary research. To achieve the overall research objectives, researcher will adapt different methods along with an in-depth review of the existing literature on the topic. Dependent and Independent Variables In order to perform this study, following dependent and independent variables will be considered: 1. Remittances as independent variable 2. Financial market development as dependent variable Secondary Research To perform this study in better manner, a systematic review of the existing literature, academic journals, textbooks and online databases will be performed. This will enable researcher to actually acquire the required data and resources to perform the research in a better and more professional manner. It will also enable the researcher to build a framework towards the construction of reliable conclusions. Secondary research will also allow the researcher to set the overall direction for the research in order to derive a more balanced and up-to-date conclusion. Through secondary research, research aims to collect enough quantitative as well as qualitative data for the remittances sent from the GCC region. Online databases as well as search engines will be used to collect the historical data of remittances sent from the region along with the understanding of the overall transaction costs related with the remittances. A thorough analysis and exploration of the data available from the Central Banks of GCC region will also be carried out in this regard. Primary Research Primary research will be further aimed at exploring the research objectives of how remittances can contribute towards the financial market development of GCC countries. At the primary research stage, some vital issues of importance will be raised to further probe the issue. It is therefore critical to note that to perform primary research effectively; right kind of data sources must be selected to perform the research study in its true spirit. Overall Approach to Research and Research Methods One of the key questions which every research should consider is to decide whether the research study will be a qualitative or quantitative in nature. Quantitative approach requires the use of statistical methods for collecting data and performing different processes in order to achieve meaningful results. Qualitative research however, has more to do with the observation and in-depth analysis of behaviors to gain an insight into the overall research objectives of this study. This research study will be primarily based upon qualitative as well as quantitative research with regression analysis being used as a major statistical tool to perform this study. Regression analysis will be performed in order to assess the relationship between the dependent and independent variables. More specifically, regression analysis will be performed to understand as to whether the expats remittances have resulted into the financial market development. Further variables will be included in the research and more specifically, regression analysis will be performed to understand the relationship and behavior between following variables: 1. Volume of remittances and intermediation/transaction cost. 2. Volume of remittances and growth in products related with remittances. This study will focus more specifically on understanding the underlying relationship between the volumes of remittances transactions with that of the intermediation cost. Researcher will clearly attempt to establish as to whether the higher volume of remittances from GCC region resulted into lower transaction costs. Low transaction cost signifies efficiency in the financial markets therefore is considered as one of the indicators of the development of financial markets. Sampling & Data Collection Sampling is a method through which researcher actually knows how many numbers of large population are necessary to achieve the overall objectives of the research. Sampling of the data from the large population therefore provides researcher different techniques to use to select the data in order to perform statistical analysis on the data. By using sampling, a researcher actually reduces the amount of data required to manipulate with in order to achieve the results for the intended objectives of the research. In order to effectively perform this research, researcher will sample out all the countries in the region with focus on evaluating the data available for top 5 banks of each country in the region. Researcher will also take last 10 years data for Remittances from each central bank of member state of GCC besides reviewing the data published in the financial statements of the top 5 banks of each country in the member states. Overall, 10 years data from each country will be obtained to measure the growth rate of remittances during that period. Data for the same period will also be obtained for intermediation cost in the region however; this data will be collected on individual as well as collective basis. Intermediation cost of each individual bank will be obtained for the same period while average intermediation cost for each year of the same period will also be collected. A review of the remittance related products and services will also be undertaken to evaluate whether the financial markets have actually responded to the increasing needs of remitters from the region. Data for last 10 years will be taken out to assess the efforts made by banks and other financial institutions for the remittances sent from the region in terms of providing efficient and cost effective introduction of new remittance products. This research will specifically exclude the remittances sent through non-formal channels i.e. remittances which are not sent through financial institutions duly approved by the Central Banks of each member country. Conclusion GCC region is considered as one of the leading economic hubs in Asia with major wealth coming from oil and oil related resources. Despite being wealthy, the financial markets of the region have not been fully developed as lack of certain resources and overall attitude towards holding wealth in non-cash items have resulted into lack of this development. Research studies suggest that the remittances can have an impact on the development of financial markets of host countries. Specifically, remittances can result into increase in competitiveness as well as reduction in the transaction costs for the consumers. By assisting institutions to become competitive by facilitating remitters through innovative product design and low costs, financial institutions can actually improve their own efficiency and develop in more sophisticated manner. With the introduction of technology, cost of sending remittances has reduced thus providing incentives to the remitters to use formal channels for the purpose of remitting money. GCC region is also the hub for expatriates and remittances from the region amounts to Billions every year. This research will attempt to explore as to whether remittances has resulted into the improvements in the financial market development process in GCC region or not. more specifically, this research study will therefore attempt to understand whether higher volume of remittances during last 10 years have resulted into low transaction costs, new product innovation and whether it has resulted into advancement and development of financial markets within GCC countries during the period under study. References 1. Billmeier. A & Massa1, A 2007. What Drives Stock Market Development in the Middle East and Central Asia— Institutions, Remittances, or Natural Resources?. 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Neaime S 2005, Portfolio Diversification and Financial Integration of MENA Stock Markets, in Simon Neaime, Nora Ann Colton (ed.) Money and Finance in the Middle East: Missed Oportunities or Future Prospects? (Research in Middle East Economics, Volume 6), Emerald Group Publishing Limited, pp.3-20 Read More