NEER and REER UPSC: Meaning, Difference and Formula

By Aarna Tiwari|Updated : October 14th, 2022

NEER and REER are indicators of external competitiveness. The Nominal Effective Exchange Rate (NEER), also known as the trade-weighted currency index, measures a nation's ability to compete in the global foreign exchange (forex) market. The Nominal Effective Exchange Rate (NEER) is adjusted for relative prices or costs to produce the real effective exchange rate (REER), which is reflected in inflation differences between the domestic economy and trading partners.

The article discusses the differences between trade-weighted indexes of REER and NEER in detail, focussing on their important aspects. The article also cites the difference between Nominal Effective Exchange Rate and Nominal Effective Exchange Rate, which is an important topic for the UPSC Exam.

Table of Content

NEER

The Nominal Effective Exchange Rate (NEER) is a weighted average exchange rate representing the nominal value of one country's currency relative to a basket of various foreign currencies. The amount of local currency required to buy foreign currency is known as the nominal exchange rate. The NEER measures a nation's ability to compete internationally in the foreign exchange (forex) market. The NEER is also known as the trade-weighted currency index by forex dealers.

The NEER may be modified to account for the difference between the inflation rates in the home country and its trading partners. The final number is the Nominal Effective Exchange Rate (REER). NEER isn't based on each currency's linkages in a nominal exchange rate individually. Instead, it illustrates how the value of one local currency contrasts with several different foreign currencies at once.

The Nominal Effective Exchange Rate can be calculated by the formula given below:

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REER

The weighted average of a country's currency concerning an index or basket of other significant currencies is the Nominal Effective Exchange Rate (REER). The relative trade balance of each country's currency is compared to the trade balance of every other country in the index to establish the weights. An individual country's currency value about the other main currencies in the index is determined using this exchange rate.

The Nominal Effective Exchange Rate can be calculated by:

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NEER vs REER

Indicators of external competitiveness include the Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) indexes. The weighted average of the domestic currency's bilateral nominal exchange rates in relation to other currencies is known as NEER. The REER, conceptually related to the purchasing power parity (PPP) hypothesis, is defined as a weighted average of nominal exchange rates adjusted for relative price differences between domestic and foreign countries.

  • The coverage of NEER/REER indexes for the new base year, i.e., 2015–16, has increased from 36 to 40 currencies due to changes in India's international trade pattern.
  • Eight new nations—Angola, Chile, Ghana, Iraq, Nepal, Oman, Tanzania, and Ukraine—have been included in the 40-currency basket due to changes in the bilateral trade shares of the largest trading partners. 
  • Argentina, Pakistan, the Philippines, and Sweden are the nations that were removed from the previous 36-currency basket.
  • 5.4 per cent of India's total merchandise trade was with newcomers, compared to 1.4 per cent with leaving nations.
  • As a result, 88 per cent of India's overall commerce is represented by the new NEER/REER basket as opposed to 84 per cent for the 36-currency basket.

>> NEER and REER UPSC [PDF]

Difference Between Nominal Effective Exchange Rate & Real Effective Exchange Rate

The difference between REER and NEER are discussed in a tabular form below.

REER

NEER

It displays the home currency's adjusted value in relation to other significant trading currencies.

It displays how much the home currency is worth in relation to other currencies.

It concentrates solely on exchange rate differentials and eliminates the effects of currency-specific inflation differentials.

It has an influence on the difference in inflation rates between the country and its trading partners.

It is thought to be a more accurate estimate as a result of being corrected for inflation.

It may provide measurements that are not exactly precise, due to differences in inflation,

This indicator is trade-weighted, and is determined using the NEER.

It is determined using a currency basket. This indicator is trade-weighted.

NEER and REER UPSC

The topic of NEER and REER is covered under the economy section of the UPSC Syllabus. One should prepare the topic well for the upcoming UPSC Exam and must refer to the Economics Books for UPSC to clear their doubts about Nominal Effective Exchange Rate and Real Effective Exchange Rate.

NEER and REER UPSC Questions

Question: Select the correct difference between the NEER and REER:

  1. While in NEER, the current rate of inflation is adjusted, it is not adjusted in REER
  2. While the rate of inflation is adjusted in REER, it is left unadjusted in the REER
  3. While the REER is calculated by the IMF for a currency, the REER is calculated by the economy whose currency it is.
  4. While the REER shows the nominal value of the exchange rate of currency, the NEER shows it in the comparative contest.

Answer: Option B

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NEER and REER FAQs

  • NEER and REER are indicators of external competitiveness. NEER full form is Nominal Effective Exchange Rate, whereas REER stands for Real Effective Exchange Rate.

  • The weighted average of the domestic currency's bilateral nominal exchange rates concerning other currencies is known as NEER. 

  • The REER, conceptually related to the purchasing power parity (PPP) hypothesis, is defined as a weighted average of nominal exchange rates adjusted for relative price differences between domestic and foreign countries.

  • REER is higher than NEER because a rise in REER may indicate that imports are becoming less expensive while exports are becoming more exclusive and costly than imports. As a result, it can be said that an increase may signal a decline in trade competitiveness.

  • Indicators of external competitiveness include the Nominal Effective Exchange Rate and Real Effective Exchange Rate indexes. To download NEER and REER UPSC Notes, click here.

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