32.Foreign Exchange Rate (Part 3)

Question 1

What is Dirty Floating?

Answer 1

Dirty Floating refers to any intervention by the Central Bank in a market determined exchange rate.

Question 2

What is Managed Float?

Answer 2

Managed Float is the term used for intervention by the Reserve Bank of India (RBI) in India’s exchange rate.

Question 3

What should be considered for export competitiveness?

Answer 3

Export competitiveness should be seen in trading partners, which is better captured through the Effective Exchange Rate.

Question 4

What is the purpose of Effective Exchange Rates?

Answer 4

Effective Exchange Rates serve as an instrument for assessing the fair value of a currency and the external competitiveness of an economy.

Question 5

How is an Effective Exchange Rate calculated?

Answer 5

An Effective Exchange Rate is a summary indicator of movements of the home currency against a basket of currency and trading partners.

Question 6

What can Effective Exchange Rates guide in an economy?

Answer 6

Effective Exchange Rates can guide the setting of monetary and financial conditions.

Question 7

What does Dirty Floating involve?

Answer 7

Dirty Floating involves intervention by the Central Bank in a market-determined exchange rate.

Question 8

What does Managed Float refer to in India?

Answer 8

Managed Float refers to the intervention by the Reserve Bank of India (RBI) in India’s exchange rate.

Question 9

What does Effective Exchange Rate capture?

Answer 9

Effective Exchange Rate captures the movements of the home currency against a basket of currency and trading partners.

Question 10

How are Effective Exchange Rates useful?

Answer 10

Effective Exchange Rates are useful for assessing currency fair value, external competitiveness, and setting monetary and financial conditions.

Question 11

What is the Nominal Effective Exchange Rate (NEER)?

Answer 11

The NEER is an index of the weighted average of the bilateral exchange rate of the home currency compared to the currency of trading partners, with weights derived from shares in the trade basket of the home currency.

Question 12

How is the Real Effective Exchange Rate (REER) different from the NEER?

Answer 12

The REER is adjusted by relative prices or cost, typically captured in inflation differentials between the home economy and trading partners.

Question 13

What does the Reserve Bank of India (RBI) consider when assessing export competitiveness?

Answer 13

The RBI looks at movements in REER and NEER as measures of export competitiveness, rather than movements of the US dollar.

Question 14

What factors should be considered for long-term export competitiveness?

Answer 14

Long-term export competitiveness should be seen in terms of product diversification, quality, product sophistication, and exploring new markets, rather than relying solely on exchange rate movements.

Question 15

What is the purpose of currency devaluation?

Answer 15

Currency devaluation is seen as a way to encourage exports and discourage imports.

Question 16

How is currency depreciation different from devaluation?

Answer 16

Currency depreciation is associated with the erosion of faith in the home currency and could potentially lead to a currency crisis situation if not managed properly.

Question 17

What are the potential consequences of a currency crisis?

Answer 17

A currency crisis represents a complete erosion of faith in the home currency and can have severe economic consequences if not effectively managed.

Question 18

How is the NEER calculated?

Answer 18

The NEER is calculated as a weighted average of bilateral exchange rates, using weights derived from the trade basket of the home currency.

Question 19

What factors are considered in adjusting the REER?

Answer 19

The REER is adjusted based on relative prices or costs, typically captured through inflation differentials between the home economy and trading partners.

Question 20

What does the RBI prioritize when assessing export competitiveness?

Answer 20

The RBI prioritizes measures of export competitiveness, such as REER and NEER, over movements in the US dollar exchange rate.