The difference between trends of NEER and REER was due to India’s domestic retail inflation being lower relative to the other 36 countries.In REER terms also, the rupee has depreciated in March and fallen to its lowest level since September 2019.The rupee has been steadily losing value - showing the Indian economy’s reducing competitiveness- since July 2019. As the chart shows, in NEER terms, the rupee has depreciated to its lowest level since November 2018.Then, in the second year, an Indian would need Rs 120 to buy the same item priced at $100, and the rupee’s exchange rate would depreciate (reduce in value) to 1.20. But suppose the Indian inflation is 20% and the US inflation is zero. This means that with Rs 100, one could buy something that was priced at $100 in the US. Illustration: Imagine that the Rupee-Dollar exchange rate was exactly 1 in the first year.Inflation is one of the most important factors. Many factors affect the exchange rate between any two currencies ranging from the interest rates to political stability (less of either results in a weaker currency).The REER is the weighted average of NEER adjusted by the ratio of domestic prices to foreign price. ![]() This is called the Real Effective Exchange Rate (REER) and is essentially an improvement over the NEER because it also takes into account the domestic inflation in the various economies. There is one more measure that is even better at capturing the actual change.A decrease in this index denotes depreciation in rupee’s value whereas an increase reflects appreciation.This is a weighted index - that is, countries with which India trades more are given a greater weight in the index.The Reserve Bank of India tabulates the rupee’s Nominal Effective Exchange Rate (NEER) in relation to the currencies of 36 trading partner countries.That is, it would want an index for the exchange rate against other currencies, just as it uses a price index (CPI or WPI) to show how the prices of goods in general have changed.Since a country interacts with many countries, it wants to see the movement of the domestic currency relative to all other currencies in a single number rather than by looking at bilateral rates.This demand in turn depends on the relative demand for the goods and services of the two countries.If the US dollar is stronger than the rupee (implying value of dollar is higher with respect to rupee), then it shows that the demand for dollars (by those holding rupee) is more than the demand for rupees (by those holding dollars). A currency’s exchange rate vis-a-vis another currency reflects the relative demand among the holders of the two currencies.The price of one currency in terms of the other is known as the exchange rate.can also be used as a proxy to compare economies. High-frequency data like sales of automobiles etc.Another measure for comparison is looking at the growth rates of Gross Domestic Product (GDP) and Gross Value Added (GVA). ![]()
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