Rupee’s Real Effective Exchange Rate (REER)

January 20, 2025

Recently, the Real Effective Exchange Rate (REER) of the Indian rupee decreased to 107.20 from a peak of 108.14 in November. This change reflects the rupee’s ongoing volatility amidst global economic shifts, including foreign portfolio investor outflows and fluctuating US Treasury yields. The REER serves as a critical indicator of India’s trade competitiveness against other currencies.

What is Real Effective Exchange Rate (REER)?

REER measures a currency’s value against a weighted average of several foreign currencies, adjusted for inflation.
It indicates international competitiveness.
A higher REER suggests reduced export competitiveness and increased import affordability.
REER is calculated by averaging bilateral exchange rates and weighting them according to trade volume. The formula can vary, but it typically reflects the relative importance of each trading partner’s currency.
REER does not account for factors like tariffs or price changes that can affect trade. It primarily reflects currency value rather than comprehensive trade dynamics.

Recent Trends in the Rupee

The rupee depreciated by approximately 3% against the US dollar in 2024.
In December, it fell by 1.31%.
The dollar index rose by 2.75% to 108.48, reflecting a stronger dollar amidst global economic conditions.

Factors Influencing REER

Heavy foreign portfolio investor outflows and a widening trade deficit contributed to the rupee’s decline. The US Federal Reserve’s unexpected rate adjustments also impacted investor confidence and currency value.

Reserve Bank of India’s Actions

In November, the Reserve Bank of India sold a record $20.2 billion in the spot market to stabilise the rupee. Despite these interventions, the rupee continued to face downward pressure, with net short positions in the forward market increasing.

Future Projections

Economists predict further depreciation of the rupee, estimating a potential decline of 20-30 paise. This projection considers external market conditions and inflation differentials with major trading partners.

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