With reference to the Indian economy, consider the following statements:

1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.

2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.

3. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.

Which of the above statements are correct?

The nominal exchange rate measures the current value of a currency against another. For example, $ 1 = Rs 70. Hence, an increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.

The real exchange rate is represented by the following equation: real exchange rate = (nominal exchange rate) X (domestic price/ foreign price).

So, while the nominal exchange rate tells how much foreign currency can be exchanged for a unit of domestic currency, the real exchange rate tells how much the goods and services in the domestic country can be exchanged for the goods and services in a foreign country.

Thus, Real Exchange rate is directly corelated to Prices of domestic goods. If the prices of domestic Goods is higher, the Real Exchange rate would also be higher.

In case of higher Real Exchange rate, Domestic Goods are costlyà Export of Domestic Goods will reduce.

Foreign Goods are cheaper Import of Foreign Goods will increase.

Thus, overall trade competitiveness of a country reduces.