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Revision of Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) Indices*

The indices of Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) are used as indicators of external competitiveness. NEER is the weighted average of bilateral nominal exchange rates of the home currency in terms of foreign currencies. Conceptually, the REER, defined as a weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries, relates to the purchasing power parity (PPP) hypothesis.

The Reserve Bank of India (RBI) has been constructing five-country and thirty six-country indices of NEER and REER as part of its communication policy and to aid researchers and analysts. Theses indices are published in the Bank’s monthly Bulletin. Three major developments as set out in the following paragraphs have necessitated a review of the existing indices.

First, introduction of the Euro (notes and coins) with effect from January 1, 2002 necessitated the need to replace the existing national currencies of the Euro zone by the common currency for the members, which formed part of RBI’s 5-country and 36-country REER/NEER indices. The European Commission (Eurostat) introduced a harmonised index of consumer prices (HICP) for the member countries, which entailed individual consumer price indices to be replaced by HICP in the construction of the REER. Second, there has been a significant shift in India’s trade relations across countries/regions, mainly towards developing and emerging economies during the last decade, requiring a change in the currency basket and the weights assigned to India’s trading partners included in the REER. Third, the base year of the Wholesale Price Index of India (WPI), was changed to 1993-94, necessitating a change in the base year for 36-country REER and NEER indices.

Against the above backdrop, the Reserve Bank has now decided to replace its existing...