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 above statements are correct?
Answer & explanation
Answer: (c) 1 and 3 only
NEER is a trade-weighted index of the rupee against partner currencies, so a rise means the rupee has appreciated. REER is NEER adjusted for relative prices: a rising REER makes Indian goods dearer abroad, which hurts competitiveness. Higher Indian inflation than abroad pushes REER up faster than NEER, widening the gap.
- ✓ 1. The RBI builds NEER as a weighted average of the rupee's bilateral exchange rates with trading partners; the index rises when the rupee appreciates against that basket.
- ✗ 2. A higher REER means the rupee is stronger in real terms, so exports cost more and imports less. The Economic Survey 2008-09 read an REER of 114.09 as a 14.1 per cent overvaluation of the rupee — a loss of competitiveness.
- ✓ 3. REER is NEER corrected for inflation differentials with trading partners. If Indian inflation keeps rising faster than theirs, REER climbs even when NEER is flat, so the two indices drift apart.
Remember · NEER up = rupee appreciated in nominal terms. REER up = rupee dearer in real terms = exports less competitive. The inflation differential is what separates REER from NEER.
Sources
- RBI Bulletin, January 2021 — Effective Exchange Rate Indices of the Indian Rupee ↗ “The nominal effective exchange rate (NEER) is an index of the weighted average of bilateral exchange rates of home currency vis-à-vis currencies of trading partners, with weights derived from their shares in the trade basket of the home currency.”
- Economic Survey 2009-10, Chapter 6: Balance of Payments ↗ “REER is defined as a weighted average of nominal exchange rates adjusted for home and foreign country relative price differentials. REER captures movements in cross-currency exchange rates as well as inflation differentials between India and its major trading partners.”
- Economic Survey 2008-09, Chapter 6: External Sector ↗ “The average six-currency trade-weighted REER (base:1993-94=100) at 114.09 in 2007-08 indicated an overvaluation of rupee by 14.1 per cent in real terms.”
Question and answer: UPSC's official GS Paper I (2022, Series A) — paper ↗ · answer key ↗. Explanation: Minimalist IAS, checked 30 Sept 2026 (how we verify). ·