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 statements given above are correct ?
- A.1 and 2 only
- B.2 and 3 only
- C.1 and 3 only
- D.1, 2 and 3
▶ Answer & Explanation
Correct answer: C. 1 and 3 only
An increase in the Nominal Effective Exchange Rate (NEER) signifies that the value of the rupee has appreciated in nominal terms against a basket of currencies. The Real Effective Exchange Rate (REER) is a more comprehensive measure, adjusted for inflation differentials; an increase in REER implies improved trade competitiveness as Indian goods become relatively cheaper for foreign buyers, or foreign goods become more expensive for Indian buyers, leading to an expansion of exports and contraction of imports. When domestic inflation rises faster than in partner countries, the nominal exchange rate must depreciate just to maintain the real exchange rate; if the nominal rate does not depreciate sufficiently, the REER will fall, indicating a loss of competitiveness. Conversely, an increasing divergence where NEER appreciates while REER falls (due to higher domestic inflation) or NEER depreciates while REER appreciates (due to lower domestic inflation) can occur.
Source: UPSC gs1 2022