What does one mean by a currency being over valued? What is Real Effective Exchange Rate (REER)?
When RBI says that the rupee is overvalued, they mean that it has been appreciating against other major currencies due to their weakening against dollar which might impact the competitiveness of India’s exports. REER is the change in the external value of the currency in relation to its main trading partners. It is Rupee’s value on a trade-weighted basis. It takes into account the Rupee’s value not only in terms of dollar but also Euro, Yen and Pound Sterling. The exchange rates versus other major currencies are average weighted by the value of India’s trade with the respective countries and are then converted into a single index using a base period which is called the nominal effective exchange rate. But the relative competitiveness of Indian goods increases even when the nominal effective exchange rate remains unchanged when the rate of price increases of the trading partner surpasses that of India’s.
