The euro has the highest weight of The real exchange rate between two currencies is the product of the nominal exchange rate and the ratio of prices between the two countries. The nominal exchange rate of the home currency with each trading partner country is multiplied by the relevant weight. The claim by the exporters that a weak rupee helps Indian exports can be refuted too.
In August , when the rupee was on a roll, this index was at Due to international trading, the prices of these goods tend to move lower in developing countries, while prices of non-tradeable goods such as real estate and some services tend to stay elevated due to lower competition. While the IMF includes trade in services by assuming that it is geographically distributed in exactly the same manner as that in manufactured goods, limitation of data is an impediment here. The central bank also needs to recast its EERs to align itself to international practices and enable this metric to reflect the actual competitiveness of the currency. The euro has the highest weight of So, the export weights assigned to China need to be adjusted to account for the competition in the third markets. The reading here is 96 and 98 respectively, for July , implying that the recent decline in the rupee has made it more competitive. Our take The question that needs to be answered now is — is the rupee overvalued? This weighted average exchange rate is the Nominal Effective Exchange Rate. The broader currency trade-based REER index with base year of , that tracks currency movement of other countries including many emerging economies such as Vietnam, Philippines, Brazil and UAE, currently reads An overvalued REER is at odds with this data. The economy is also going to face difficulty with widening current account deficit, reducing foreign fund flows, falling reserves and imported inflation. An index of these rates is computed from a base-year — Given that a weak rupee is not helping exports either, it will be better if policy makers give serious thought to whether they want the rupee to continue depreciating in this manner. Other Asian currencies such as the Chinese yuan, Thai Baht, Singaporean dollar etc have appreciated around 20 per against the dollar and more than 25 per cent against the euro in this period. To explain third market competition, India exports as well as imports goods from China. Read the rest of this article by Signing up for Portfolio. If double-weighting were done to take into account third market competition, countries such as Vietnam, Bangladesh and Philippines and China will have a much higher weight in the broad rupee REER, since exporters from these countries compete with Indian exporters in overseas markets. The Balassa Samuelson effect Luis A V Catao of IMF, while explaining the rationale for real exchange rates, wrote that there could be some structural changes taking place in developing economies that could be taking their REERs higher. Catao writes that both theory and data support that much of the REER variations across countries are accounted for by fluctuations in the prices of non-tradables relative to those of tradeables, particularly so among developing countries. The EERs, as computed by all agencies, also suffer from some common defects such as difficulty in accounting for international vertical specialisation, wherein one country imports parts and ships out the final assembled product such as China. This is represented by the number of standard deviations the value is placed away from the mean value of the BIS broad REER index for emerging market currencies, computed by Bloomberg. This is the head-line number quoted by all. The nominal exchange rate of the home currency with each trading partner country is multiplied by the relevant weight. The REER is generally considered an indicator of international competitiveness. Housing and other services have around 38 per cent weight in our CPI basket. Both seem to imply that, in nominal terms, the rupee has corrected more than its trading partners.
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