How Remittances Affect the Exchange Rate

Remittances affect the exchange rate through one simple channel: they arrive as foreign currency, get converted into rupees for the household receiving them, and so add to the supply of dollars in the interbank market. More dollars offered, other things equal, means a firmer rupee.

Other things are almost never equal — and in Pakistan's case the causation also runs backwards, from the exchange rate to the remittance figure itself. This piece works through both directions, using the fiscal year that demonstrated them most clearly. For the wider picture on where the money comes from and what else it does, see the complete guide to remittances to Pakistan.

The short answer

Remittances support the exchange rate but do not set it. They are one source of dollar supply competing against import demand, external debt repayments and hedging demand. When those grow faster, the rupee can weaken in a record remittance year. When they don't, the rupee holds — and a stable rupee then pulls even more flow into the formal channel, which raises the recorded remittance number again.

The mechanism, in one pass

Follow a single transfer. A construction worker in Riyadh sends 1,000 dollars home. Those dollars enter Pakistan's banking system, where the receiving bank credits the household in rupees at the prevailing rate. The bank now holds dollars it did not have and has parted with rupees. In aggregate, across billions of dollars a month, that is a standing bid for rupees and a standing offer of dollars.

Against that sit four sources of demand for the same dollars:

1. Importers, who need foreign currency to settle letters of credit. This is by far the largest and it scales with the import bill.
2. The government and corporates servicing external debt, whose obligations fall due on a schedule regardless of what the rate is doing.
3. Profit repatriation by foreign-owned firms.
4. Anyone hedging, because an expected depreciation is itself a reason to buy dollars now.

The exchange rate is where those two sides clear. Remittances are the most dependable line on the supply side — they arrive without creating a repayment obligation and they don't reverse when sentiment turns — but they are still only one line.

This is why "remittances hit a record, so why is the rupee still falling?" is not a paradox. It is arithmetic. In a year when the import bill grows faster than remittances, the supply side loses even as it sets a record.

The worked example: Pakistan's FY26

FY26 — the year to June 2026 — is unusually instructive, because almost everything moved at once and not all of it in the same direction.

Remittances set a record. Workers' remittances reached $41.6 billion, up from $38.3 billion in FY25 — an increase of roughly 8.6%.

The rupee gained, steadily. It closed the year at 278.16 to the dollar against 283.76 twelve months earlier: a gain of Rs5.60, or about 2%. More striking than the size was the consistency — the rupee posted gains in all twelve months of the fiscal year, something that had not happened in thirteen fiscal years. By the close, the open market was quoting 278.82 and 279.44 for buying and selling, within a few tenths of a percent of the interbank rate.

But the trade side went the other way. Goods imports climbed to $58.46 billion over the first eleven months, up about 8%, while goods exports fell about 5% to $28.25 billion.

And the current account slipped. Pakistan closed FY26 with a deficit of $139 million, against a surplus of $1.84 billion the year before.

Why a record year still produced a deficit

Put those together and the tension resolves cleanly.

The goods gap over those eleven months was about $30.2 billion. Remittances of $41.6 billion were roughly 138% of it — they more than covered the entire deficit on merchandise trade. (That coverage ratio is my own calculation: the published goods import and export figures differenced, divided into the annual remittance total. It compares an eleven-month trade figure with a twelve-month remittance figure, so treat it as an indication of scale rather than a precise ratio.)

And the current account still went negative, because the goods gap is not the whole account. Services run a deficit of their own. Primary income — interest on external debt, profits repatriated by foreign firms — is a persistent outflow. Remittances have to cover the goods gap and those, and in FY26 they fell $139 million short.

That number is small enough to be almost a rounding error on a $69 billion trade flow. But the direction matters: FY25's surplus became FY26's deficit while remittances were setting records. Nothing about the remittance line caused that. The import bill and the export slide did.

The misconception: the causation runs both ways

Here is the part that most commentary gets wrong, and it is the reason FY26 is worth studying rather than just reporting.

A stable exchange rate does not merely result from strong remittances. It produces stronger recorded remittances.

The mechanism is the spread between the official rate and the open-market or kerb rate. When that gap is wide, an informal operator can offer the sender a materially better rate than a bank can, and flow migrates out of the banking system into hundi and hawala. Those transfers are real — the family still receives the money — but they never appear in the State Bank's remittance series, because the central bank can only count what passes through formal channels.

When the gap narrows toward zero, that arbitrage disappears. The informal operator's advantage was the rate; without it, the bank wins on safety, traceability and convenience. Flow returns to the formal channel and the recorded number rises.

In FY26 the premium between official and market rates narrowed to very little — a few tenths of a percent at the year's close. Some meaningful part of the 8.6% rise in recorded remittances is therefore best read not as more money being sent, but as the same money being sent by a different route.

This matters for three reasons:

• It changes what the number means. A jump in recorded remittances after an exchange-rate stabilisation is partly a measurement effect, not purely an income effect. Reporting it as a straightforward surge in diaspora generosity overstates what happened.
• It makes the relationship reflexive. Remittances support the rate; the rate determines how much of the flow gets recorded. Any analysis treating remittances as a purely exogenous input to the exchange rate has the causality half backwards.
• It sets a trap for forecasts. A one-off formalisation gain does not repeat. Once the flow has moved into banks, the following year has to grow on the underlying income, from a higher base.

The wider question of how remittances interact with the domestic financial system — and how much the effect depends on whether recipients are actually banked — is the subject of my work with colleagues in Cogent Economics & Finance, which finds the growth effect of remittances is conditional on financial inclusion rather than automatic.

How to measure the change properly

One methodological note, because it recurs every year and it is easy to get wrong.

Published figures for FY26's appreciation vary between roughly 2% and 3.5%, and both can be defended. The difference is the basis. Comparing the closing rate of FY26 with the closing rate of FY25 — 278.16 against 283.76 — gives a gain of Rs5.60, which is 1.97% of the old rate or 2.01% of the new one. Comparing average rates across each fiscal year gives a different, usually larger, figure, because the rupee spent the first part of FY25 considerably weaker.

Neither is wrong; they answer different questions. Closing rates tell you where the currency ended up. Average rates tell you what importers and exporters actually transacted at. Just never mix the two in the same sentence, and always say which you used. This piece uses closing interbank rates throughout.

What to watch next

If you want to know whether the FY26 pattern holds, three indicators lead the remittance line rather than follow it:

1. The interbank-to-open-market spread. This is the single best early warning. A widening premium means flow is about to migrate informal, and recorded remittances will soften a month or two later — with no change in what anyone abroad is actually sending.
2. The monthly import bill. Remittances only matter relative to what must be paid out. FY26's deficit came from imports rising 8%, not from remittances underperforming.
3. Export performance. A 5% decline is the structural problem underneath all of this. Remittances can cover a goods gap indefinitely; they cannot close it, because closing it requires selling more abroad.

FY26 answered the question people usually ask — can record remittances hold the rupee up? — with a qualified yes. The more useful question for FY27 is how much of that record was new money and how much was old money taking a new route, because only one of those can happen twice.