Significance
- How many rupees are required to buy a US dollar.
If Rupee Falls
- Costly Import & Competitive Export
Determination?
- Decided by the supply and demand for rupees and dollars
Effective Exchange Rate (EER)
- Summary of the movement indication of the domestic currency against a complete basket of other global currencies of its trading partners.
- Competitive the domestic currency is assessed as compared to the other currencies that the country trades with.
- The NEER may be defined as a weighted average of one country’s currency that is needed to purchase a foreign currency.
If Inflation in India increases as compared to its trading partners.
It will result in high Prince Index Ratio
Which will eventually increase the Divergence between NEER and REER
Where CER is Currency Exchange Rate
Weight is Weightage of Currency (40% = .4)
Example:
Country 1 ; CER =82 and Weight = 40%
Country 2 ; CER =60 and Weight = 40%
Country 3 ; CER =55 and Weight = 20%
NEER = 66.81
- P and Pi represent price index of home country and price index for trade partner country
- The REER, defined as a weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries.
Where PR is Price index ratio (P/Pi)
REER
- Measures the health of a nation’s currency against that of the countries it trades with and is an indicator of the international competitiveness of a nation.
- An increase in REER implies that exports become more expensive and imports become cheaper; therefore, an increase indicates a loss in trade competitiveness.
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