Note4Students
From UPSC perspective, the following things are important :
Prelims level: Real Effective Exchange Rate (REER)
Why in the News?
The rupee has been hitting record lows against the US dollar but has simultaneously reached an all-time high in real effective terms. In November 2024, the Real Effective Exchange Rate (REER) index of the rupee touched 108.14, strengthening by 4.5% during the year, according to the RBI.
What is Effective Exchange Rate (EER)?
- The Effective Exchange Rate (EER) measures the value of a currency relative to a basket of currencies from its major trading partners.
- EER is a weighted average of exchange rates, reflecting the importance of each trading partner in a country’s total foreign trade.
- Types of EER:
- Nominal Effective Exchange Rate (NEER):
- NEER is the weighted average of a currency’s exchange rates with the currencies of its trading partners.
- It does not adjust for inflation, representing only nominal changes in currency value.
- Higher NEER: Indicates the domestic currency has appreciated compared to the basket of currencies.
- Real Effective Exchange Rate (REER):
- REER adjusts NEER for inflation differentials between the country and its trading partners.
- It measures the real purchasing power of a currency, providing insights into its competitiveness in international trade.
- The base year for REER in India is 2015-16, set at 100.
- REER > 100: Indicates an overvalued currency, making exports less competitive.
- REER < 100: Indicates an undervalued currency, making exports more competitive.
How does it impact Exports?
REER provides a real measure of currency competitiveness, adjusted for inflation:
- REER > 100 (Overvalued Currency):
- Exports suffer, as Indian goods and services become expensive in global markets.
- Imports rise, as foreign goods become cheaper in comparison.
- May lead to a widening trade deficit.
- REER < 100 (Undervalued Currency):
- Exports thrive, as Indian goods and services are priced more competitively in global markets.
- Imports decrease, as foreign goods become relatively expensive.
- Improves the trade surplus and supports domestic industries.
PYQ:[2022] With reference to the Indian economy, consider the following statements:
Which of the above statements are correct? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 |
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