India’s Real Effective Exchange Rate (REER) measures the value of Indian rupee against the basket of other currencies. If REER is on lower side then
(a) the rupee becomes stronger
(b) the rupee becomes marginally more competitive in international markets.
(c) the rupee is undervalued.
(d) the rupee reaches equilibrium.
Explanation Overview: Conceptually, the REER, defined as a weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries, relates to the purchasing power parity (PPP) hypothesis. The rupee is considered to be fairly valued if the REER is close to 100 or the base-year value. Other things remaining the same, higher domestic inflation vis-à-vis its trade partners will reflect in appreciation of the REER and hence there is a view that the nominal exchange rate should depreciate to keep it at base-year levels.
Option (b) is correct: The REER, which measures the value of the Indian rupee against a basket of other currencies, slightly decreased from 105.44 in August to 105.15 in September 2024. A lower REER indicates that the rupee became marginally more competitive in international markets.
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