Real Effective Exchange Rate (REER)

About NEER and REER:

• NEER (Nominal Effective Exchange Rate): It is the weighted average of a currency’s bilateral exchange rates with multiple trading partner currencies.
  • NEER reflects the nominal strength of a currency but does not adjust for inflation or price level differences.
  • A rise in NEER indicates nominal appreciation, while a decline signals depreciation.
• REER (Real Effective Exchange Rate): An improvement over NEER, it adjusts for relative price levels (inflation) between domestic and foreign economies.
  • Calculated as: NEER × (Domestic Price Index ÷ Foreign Price Index).
  • It is a purchasing power parity (PPP)-adjusted measure of competitiveness.
• Currency basket for India’s Indices: Earlier, the NEER and REER indices included six major currencies: US Dollar (USD), Euro (EUR), Japanese Yen (JPY), British Pound (GBP), Chinese Yuan (CNY), and Singapore Dollar (SGD).
  • The indices now encompass a broader basket of 36 currencies, reflecting India’s diverse trade relations.
• Factors influencing NEER and REER:
  • Productivity Differences: Affect competitiveness and influence REER values.
  • Terms of Trade: The balance of exports and imports can impact both indices.
  • Inflation: Higher inflation erodes currency value, affecting REER.
  • Fiscal Spending: Impacts economic stability and demand, influencing exchange rate dynamics.

Key Updates on REER:

• Record High REER: The Reserve Bank of India (RBI) has reported that the rupee's Real Effective Exchange Rate (REER) reached 14 in November 2024, increasing from 107.20 in October 2024. This marks its highest level this year.
• Implications of Overvaluation: A REER value above 100 signifies that the rupee is overvalued relative to the base year (2015-16), leading to reduced export competitiveness while making imports cheaper.