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?

QUESTION

Medium

Economy

Prelims 2022

With reference to the Indian economy, consider the following statements:

An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
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?

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Explanation

Statement 1 is correct. The nominal Effective Exchange Rate (NEER) is a measure of the value of a country's currency against a basket of other currencies weighted by their importance in trade. If NEER increases, it means that the value of the currency has increased relative to the currencies in the basket, indicating appreciation.
Statement 2 is incorrect. The Real Effective Exchange Rate (REER) takes into account both nominal exchange rates and relative price levels (inflation) between countries. An increase in REER means that the country's currency is overvalued relative to its trading partners, which can reduce trade competitiveness.
Statement 3 is correct. If domestic inflation is higher than inflation in other countries, the real value of the domestic currency decreases faster than the nominal value, causing a divergence between NEER and REER.

Therefore, the correct statements are 1 and 3.

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