Nominal Effective Exchange Rate (NEER): Meaning & Calculation | UPSC Notes

Nominal effective exchange rate NEER is a measure used to evaluate the value of a country's currency relative to a basket of other major currencies, weighted by the relative importance of each currency to the country's trade. Unlike REER, NEER does not account for price-level differences across countries. It gives the snapshot of the strength of currency at an international scale, purely in nominal terms and not adjusted for differences in inflation, which becomes an important indicator in any economic analysis.

This topic falls under the General Studies Paper III of UPSC Civil Services Examination, particularly under the subject of Economic Development. Understanding the exchange rate, more so NEER and REER, assumes significant importance to comprehensively analyze global economic dynamics and trade policies, and the impact these will have on India's economy. It helps aspirants get a grip on the complexities of economic indicators and how they shape national economic strategies.

What is an Effective Exchange Rate (EER)?

The Effective Exchange Rate is a kind of index which describes the strength of a country's currency against some foreign currencies in a weighted average. The weights are set with respect to the relative importance of different foreign currencies in influencing the trade balance of the country. In contrast with the bilateral exchange rate, the EER would measure international competitiveness against a single foreign currency. There are basically two types of EER:

• Nominal Effective Exchange Rate: A nominal rate is one that measures the currency without considering the impact of inflation.
• Real Effective Exchange Rate: Refines the concept of NEER by including differences in national price levels to obtain a truer value of a currency's real worth.

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What is a Nominal Effective Exchange Rate (NEER)?

NEER stands for Nominal Effective Exchange Rate, which is the weighted average of a country's currency value against a basket of other major currencies, but in relation to nominal exchange rates. The weights are usually assigned according to the importance of the respective currencies in trade for the country under consideration. NEER measures the relative strength and performance of a country's currency on a nominal basis.

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Nominal Effective Exchange Rate in the Indian Context

The Reserve Bank of India releases the NEER index periodically, which reflects the rupee's movement against a basket of several currencies. This includes USD, the Euro, the British Pound, the Japanese Yen, and the Chinese Yuan, among others, weighted based on their importance in India's external trade.

The NEER index serves to underscore the rupee's international competitiveness to policymakers, economists, and investors. A rise in the NEER index would imply appreciation of the rupee on a nominal basis against a basket, and vice versa. However, in order to get an overall picture, it is equally important to look at REER because NEER by itself is not going to capture the differences in inflation rates, which are a major determinant of competitiveness.

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Difference Between Nominal Effective Exchange Rate and Real Effective Exchange Rate

The key difference between Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) lies in inflation adjustment:

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Conclusion

An insight into the nominal effective exchange rate is quite important in as far as appreciating or depreciating the trend of a country's currency value against its trading partners. NEER is one of the key metrics most economists and policymakers use to assess a country's exchange rate policies and standing in the global economy. While NEER gives the important snapshot of nominal currency strength, it is necessary to put this against REER for a clearer image of economic competitiveness. In the context of Indian economic policy, both NEER and REER will turn out to be extremely useful in making correct decisions related to international trade and monetary policies.

We hope your doubts regarding the topic have been addressed after going through the above article. Testbook offers good quality preparation material for different competitive examinations. Succeed in your UPSC IAS exam preparations by downloading the Testbook App here!