Rupee Weakens as REER Hits High Record

                                                                                         Syllabus: GS 3/Economy

Recent Context

• According to the most recent Reserve Bank of India (RBI) data, the rupee's Real Effective Exchange Rate (REER) index reached a record 108.14 in November 2024, rising by 4.5% over this fiscal year.

  
  

Difference Between REER and NEER

REER	NEER
The weighted average of a country’s currency in relation to an index or basket of other major currencies.	The value of a country's currency compared to a weighted average of its opponent partners' currencies.
REER is adjusted NEER based on differential inflation rates among two trading nations.	It is determined as a weighted average of nominal exchange rates between the domestic currency and the foreign currencies of the trading partners.
It presents a better comparison and reflection on how the particular nation stands concerning competitiveness at an international level.	NEER operates without accounting for inflation differences.
REER is a good indicator of competitiveness in an economy because it shows price changes that affect trade flows.	NEER is only showing raw exchange rates.
REER adjusts for inflation to provide a more accurate assessment of a currency's real value.	NEER focuses on nominal exchange rate value changes in relation to the basket of currencies.

The REER is a more comprehensive measure of a currency’s value because it accounts for the rupee’s exchange rate not just against the dollar but also against a basket of 40 global currencies, which represent 88% of India’s total trade.

Impact on Exports

• A higher REER makes Indian goods less competitively priced globally, which could result in a decrease in exports. Although there is a risk of inflation, a lower REER increases price competitiveness and increases exports.

Impact on Imports

• A higher REER lowers the cost of imports, which pushes the trade deficit and increases import quantities. Import prices rise with a lower REER, which fuels domestic inflation, particularly for necessities like oil.

What Should India Do?

1. Enhancing Export Competitiveness: India should concentrate on increasing the quality of exports through investments in innovation and technology, mainly in high-value sectors such as IT services, pharmaceuticals, and electronic manufacturing.

• The government can also offer incentives like export credit, tax reliefs, and trade facilitation measures to make Indian exports more competitive despite a higher REER.

2. Diversifying the Trading Partners: India should diversify its trade relationships to reduce dependence on any single economy to reduce the impact of a strong REER against specific countries.

3. Promoting Domestic Manufacturing: India needs to make its domestic industries strong through schemes like 'Make in India' so that it encourages local production of goods imported, especially oil, energy, and essential commodities, to avoid inflationary pressures from a weak REER.

4. Accumulation of Foreign Exchange Reserves: A steady increase in foreign exchange reserves can strengthen the economy against currency fluctuations. The RBI could aim to build reserves during periods of a strong INR to handle future depreciation.

5. Strengthening Monetary Policy Tools: The RBI needs to monitor the REER closely and change its monetary policies to keep inflation under control and ensure economic stability. Repo rates, open market operations, and currency interventions can be utilized as tools.

6. Inflation Management: India needs to tackle inflation by doing supply-side reforms, improving agriculture, logistics, and energy efficiency, and in the process of maintaining the exchange rate so that even the shocks through REER fluctuations do not get inflation out of hand.

Conclusion

• The REER has a crucial role in determining the economic competitiveness of India, the trade balance, and the level of inflation. Even though the fluctuations in the REER reflect market realities, the government and the RBI should ensure that these fluctuations are managed in order to maintain overall economic growth and stability. In the future, India needs to focus on strengthening its export base, enhancing domestic manufacturing, and improving policy coordination to sustain growth in changing global economic conditions.

UPSC Mains Model Question

Q. Examine how important the Real Effective Exchange Rate (REER) is to India's economy and commerce. What distinguishes it from NEER, or the nominal effective exchange rate? Discuss the challenges India faces in managing REER and suggest measures to stabilize it given the state of the global economy. (250 words)