Source: IE
Context: The real effective exchange rate (REER) index of the rupee touched a record 108.14 in November, strengthening by 4.5 per cent during this calendar year, according to the latest RBI data.
About Real Effective Exchange Rate (REER):
- What it is: REER is a weighted average of a nation’s currency value against the currencies of its trading partners, adjusted for inflation.
- Factors determining REER:
- Nominal Exchange Rates: Bilateral currency values.
- Inflation Differentials: Variances in inflation between a country and its trading partners.
- Trade Weights: Relative importance of each trading partner in the home country’s trade.
- How to calculate REER:
- Average bilateral exchange rates are weighted by the trade significance of each partner.
- Adjust for inflation to convert the nominal effective exchange rate (NEER) to REER.
- Formula:
- What REER indicates in the economy:
- Increase in REER: Indicates currency overvaluation, making exports costlier and imports cheaper, reducing trade competitiveness.
- Decrease in REER: Suggests currency undervaluation, improving export competitiveness and raising import costs.
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