Balance-of-payments / Balance of Payments / Real Value of the Rupee
The real value of a currency is a crucial aspect that goes beyond its nominal or official exchange rate. It involves understanding the actual purchasing power and competitiveness of the currency in the global market. Here are three perspectives on the value of the rupee:
- Nominal Effective Exchange Rate (NEER):
- NEER represents the official or nominal exchange rate at a given point in time.
- It reflects the value of the rupee against foreign currencies based on prevailing market rates.
- Real Effective Exchange Rate (REER):
- REER takes inflation into account, providing an inflation-adjusted exchange rate.
- It considers the differential between the inflation rates in India and its trading partners.
- REER is a notional indicator that helps assess whether the rupee is overvalued or undervalued.
- The Reserve Bank of India (RBI) uses a 36-country REER as an indicator for macroeconomic analysis.
- Purchasing Power Parity (PPP) Method:
- PPP is a method that compares the relative value of currencies by evaluating the price levels of a basket of goods and services.
- It helps determine whether a currency is overvalued or undervalued based on its ability to buy a standard set of goods.
- The PPP method considers long-term equilibrium exchange rates.
Currency Valuation and Impact:
- Overvaluation: A strong or overvalued rupee makes Indian exports more expensive in foreign markets while making imports cheaper domestically.
- Undervaluation: A weak or undervalued rupee makes Indian exports more competitive in foreign markets while raising the cost of imports domestically.
