External Sector› Exchange Rate & Rupee Management
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?
Answer c.
Answer c: statements 1 and 3 are correct. A rising NEER does mean the rupee is appreciating, and a domestic-inflation gap does widen the NEER–REER divergence, but a rising REER signals a loss, not a gain, in trade competitiveness. NEER is the trade-weighted average value of the rupee against a basket of partner currencies, so a higher NEER means each rupee buys more foreign currency — an appreciation (statement 1 correct). REER is NEER adjusted for relative price levels; when REER rises, Indian goods become dearer relative to competitors', so exports lose price competitiveness — statement 2 has the direction reversed. Because REER = NEER × (domestic prices / partner prices), higher domestic inflation than partners' pushes REER above NEER even when NEER is flat or falling, so the two indices diverge (statement 3 correct). The RBI publishes 6-currency and 40-currency NEER/REER indices monthly in its Bulletin.
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