NEER (Nominal Effective Exchange Rate) and REER (Real Effective Exchange Rate) in India
NEER (Nominal Effective Exchange Rate) and REER (Real Effective Exchange Rate) are key indicators used to measure the value of a country’s currency relative to a basket of other currencies. These indices help assess the overall strength or weakness of a currency in the global market and provide insights into the competitiveness of a country’s goods and services in international trade.
NEER: Nominal Effective Exchange Rate
NEER is an index that measures the value of a country’s currency against a weighted average of several foreign currencies. The weights are typically based on the trade volume with each country, meaning that currencies of major trading partners have a more significant influence on the NEER.
How NEER is Calculated:
- Currency Basket: NEER is calculated using a basket of currencies that represent the country’s major trading partners.
- Trade Weights: The currencies in the basket are assigned weights based on the proportion of trade (imports and exports) that the country conducts with each partner.
- Nominal Exchange Rates: The nominal exchange rates of the domestic currency against each foreign currency are used.
- Index Calculation: NEER is an index number, usually set to 100 in a base year, that reflects the weighted average change in the exchange rate of the domestic currency against the basket of currencies.
Interpretation:
- NEER > 100: If the NEER is greater than 100, it indicates that the domestic currency has appreciated relative to the base period.
- NEER < 100: If the NEER is less than 100, it suggests that the domestic currency has depreciated relative to the base period.
Example:
Suppose India’s NEER against a basket of currencies (including the US Dollar, Euro, Yen, etc.) is calculated, and the index value is 105. This would indicate that the Indian Rupee (INR) has appreciated by 5% relative to the currencies of its trading partners compared to the base year.
REER: Real Effective Exchange Rate
REER is an index that adjusts the NEER by taking into account the relative price levels or inflation rates between the domestic country and its trading partners. It is a more accurate measure of a country’s currency competitiveness because it considers changes in price levels, which affect the real purchasing power of the currency.
How REER is Calculated:
- Starting with NEER: REER is derived from the NEER by adjusting for the relative inflation rates between the domestic country and each of its trading partners.
- Price Levels: The consumer price index (CPI) or producer price index (PPI) is often used to represent the price levels in each country.
- Index Adjustment: The NEER is adjusted by the ratio of domestic price levels to the foreign price levels, resulting in the REER.
Interpretation:
- REER > 100: If the REER is greater than 100, it indicates that the domestic currency has appreciated in real terms, meaning the country’s goods and services have become relatively more expensive for foreign buyers.
- REER < 100: If the REER is less than 100, it suggests that the domestic currency has depreciated in real terms, meaning the country’s goods and services have become relatively cheaper for foreign buyers, improving trade competitiveness.
Example:
If India’s REER is 95, this implies that the INR, after adjusting for inflation, has depreciated by 5% relative to its trading partners compared to the base year. This could make Indian exports more competitive internationally.
NEER and REER in India: Practical Insights
1. Tracking Competitiveness:
- NEER: Reflects changes in the nominal exchange rates of the INR against a basket of currencies. However, it does not account for inflation differentials, so it may not fully reflect changes in competitiveness.
- REER: Adjusts for inflation, providing a better measure of competitiveness. A rising REER can indicate that Indian goods are becoming more expensive relative to foreign goods, potentially reducing export competitiveness.
2. Policy Implications:
- Monetary Policy: The Reserve Bank of India (RBI) monitors NEER and REER to assess the impact of its monetary policy on the exchange rate and overall economic competitiveness. If the REER indicates significant appreciation, the RBI may take measures to prevent a loss of export competitiveness.
- Exchange Rate Management: Understanding the trends in NEER and REER helps the RBI decide when to intervene in the forex market. For example, if the REER shows excessive appreciation, the RBI might intervene to weaken the INR to support exports.
3. Impact of Global Events:
- Example: During the COVID-19 pandemic, global demand and trade patterns shifted, impacting the NEER and REER. If India’s trading partners experienced higher inflation compared to India, the REER would decrease, signaling improved competitiveness for Indian goods. Conversely, if India had higher inflation, the REER would increase, potentially hurting exports.
4. Case Study: Indian Rupee in 2021-2023:
- NEER Trends: Between 2021 and 2023, the INR experienced fluctuations in its NEER due to various factors, including global economic conditions, changes in trade flows, and capital movements. A weaker NEER during this period indicated that the INR had depreciated nominally against a basket of currencies.
- REER Trends: The REER, however, showed a different trend. While the NEER indicated depreciation, the REER might have shown less movement or even appreciation if domestic inflation was lower than that of trading partners. This indicated that, in real terms, the competitiveness of Indian goods had not improved as much as the NEER might suggest.
Conclusion
NEER and REER are crucial tools for understanding the value of the Indian Rupee in the global market. While NEER provides a snapshot of the currency’s nominal value against a basket of currencies, REER offers a deeper insight by adjusting for inflation differentials, giving a more accurate picture of the currency’s real value and its impact on trade competitiveness. For policymakers, businesses, and investors, monitoring NEER and REER is essential for making informed decisions related to trade, investment, and monetary policy.
