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 ?
- (a) 1 and 2 only
- (b) 2 and 3 only
- (c) 1 and 3 only ✓ UPSC's answer
- (d) 1, 2 and 3
Why the answer is (c)
• The NEER is a trade-weighted index of the rupee against a basket of currencies; the REER adjusts it for relative inflation.
• Statement 1 is correct: a rise in NEER means the rupee has appreciated against the basket in nominal terms.
• Statement 2 is wrong: a rise in REER means Indian goods have become more expensive relative to trading partners — a loss, not a gain, in trade competitiveness.
• Statement 3 is correct: if India's inflation runs higher than its partners', REER rises faster than NEER, widening the gap between the two indices.
• Hence 1 and 3 only, option (c).
Why the other options are wrong
- (a) 1 and 2 only
- Statement 2 is wrong: a rising REER reduces competitiveness.
- (b) 2 and 3 only
- Statement 2 is wrong; statement 1 is correct.
- (d) 1, 2 and 3
- Statement 2 is wrong, so all three cannot be correct.
Asked in the GS Paper I of the UPSC Civil Services Preliminary Examination 2022, held on 5 June 2022. Question and answer key: Union Public Service Commission. Explanation: UPSC Answer Check.