REAL EFFECTIVE EXCHANGE RATE: ECONOMY

REAL EFFECTIVE EXCHANGE RATE: ECONOMY

NEWS: As rupee hits new lows, real effective exchange rate soars to an all-time high

 

WHAT’S IN THE NEWS?

The Real Effective Exchange Rate (REER) of the Indian Rupee reached a record 108.14 in November 2024, indicating a 4.5% appreciation this year. A higher REER suggests the rupee has appreciated, making exports more expensive and imports cheaper, potentially impacting India's trade competitiveness.

 

Real Effective Exchange Rate (REER):

1. Definition and Calculation: The Real Effective Exchange Rate (REER) is a comprehensive measure that compares a country’s currency against a weighted average of the currencies of its major trading partners, adjusting for inflation. This index is crucial because it reflects a nation's overall competitiveness in international trade. Unlike the nominal exchange rate, which only reflects the relative value of a currency, REER accounts for changes in the price levels within the country and its trading partners, allowing for a more accurate comparison of a country's real trade position.

 

2. How REER is Calculated:

  • Nominal Exchange Rate: The value of a currency relative to another currency (e.g., how many rupees one U.S. dollar can buy).
  • Weighting: The currencies of a nation’s major trading partners are given weight based on trade volume or economic significance. For example, the U.S. dollar, euro, and Chinese yuan would likely be highly weighted for India.
  • Adjustment for Inflation: REER adjusts for inflation, both domestic and foreign. This means that it takes into account price changes that affect the actual purchasing power of the currency, offering a clearer picture of a country's competitiveness.

For example, if India's inflation rate is higher than that of its trading partners, the real value of the rupee would be considered weaker even if the nominal exchange rate doesn’t change significantly.

 

Source: https://indianexpress.com/article/business/economy/as-rupee-hits-new-lows-real-effective-exchange-rate-soars-to-an-all-time-high-9744407/