The rupee has lost more than 18.5 per cent of its value in dollar terms between August 2011 and May 2012 . But this value reflects only the nominal exchange rate — the price value of one currency with respect to another.

Nominal Effective Exchange Rate (NEER) which tracks the rupee movement against 36 currencies, weighed according to trade with those countries, depreciated by 13 per cent.

A more informative indicator — the real exchange rate — shows that the loss in the “real value” of rupee during the period is 10.9 per cent.

About real exchange rate

Real Exchange Rate, also called Real Effective Exchange Rate (REER), measures the ratio of price differential of goods with respect to nominal exchange rates.

Since this measure includes the level of inflation differences across nations, it reflects a country's competitiveness in international trade.

REER is represented as an index value — a value that indicates the extent of change in a variable over time — usually, with respect to a base year.

The base-year value of REER is 100, and values less than 100, indicate that either domestic prices have decreased relative to foreign prices, or the nominal exchange rate has depreciated, or both.

As of May 2012, REER (based on 36-currency trade weights) in India stood at 91.22.

The RBI releases two REER indices: One with respect to six currencies, and another with respect to thirty six.

The current REER indexes for both the currency basket use 2004-05 as the base year. The RBI uses wholesale price index for India and consumer price index for other currencies to calculate inflationary differences.

Trends in NEER and REER

From fiscal year 2004-05 to 2011-12, for the 36 currencies basket, the NEER depreciation stood at 12.4 per cent, while the loss in REER was only 1 per cent with the value of REER at 99. Huge divergences between NEER and REER have occurred earlier too. The INR spot between December 2007 and March 2009 fell by 23 per cent, while the REER fell by 16 per cent.

Typically, if the rate of inflation across nations is similar, depreciation in NEER would lead to a corresponding fall in value of REER. But India's inflation rate has been typically higher than that of other countries in the last few years. This trend suggests that the country's competitiveness (measured by REER) has not improved as much as the decline in nominal exchange rate points out.

It is time for inflation to correct so that our country does not lose out on competitive edge in trade.

mvssanthosh@thehindu.co.in

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