Q. With reference to the Indian economy, consider the following statements:
1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
3. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.
Which of the above statements are correct?
Exp) Option c is the correct answer.
The indices of Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) are used as indicators of external competitiveness.
Statement 1 is correct: NEER is the weighted average of bilateral nominal exchange rates of the home currency in terms of foreign currencies. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
Statement 2 is incorrect: REER is the weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries.
An increase in a nation’s REER is an indication that its exports are becoming more expensive and its imports are becoming cheaper. Means, it is losing its trade competitiveness.
Statement 3 is correct: A real effective exchange rate (REER) is the NEER adjusted by relative prices or costs, typically captured in inflation differentials between the home economy and trading partners. A nation’s nominal effective exchange rate (NEER) when adjusted for inflation in the home country, equals its real effective exchange rate (REER). Higher the inflation higher will be divergence (difference between) NEER and REER.
Source) https://www.rbi.org.in/Scripts/BS_ViewBulletin.aspx?Id=20020
https://www.indiabudget.gov.in/budget_archive/es2007-08/chapt2008/chap611.pdf
https://www.investopedia.com/terms/r/reer.asp
