Correct Option
Statement 1 is correct. The Nominal Effective Exchange Rate (NEER) is a weighted average of a country's currency value relative to a basket of major foreign currencies. An increase in the NEER signifies an appreciation of the domestic currency (rupee) against this basket, meaning more foreign currency can be exchanged for one unit of the domestic currency.
Statement 3 is correct. The Real Effective Exchange Rate (REER) is the NEER adjusted for inflation differentials between the domestic country and its trading partners. If domestic inflation is higher than inflation in other countries, the purchasing power of the domestic currency declines relatively faster at home. This inflation differential causes the REER to rise more rapidly or diverge from the NEER, indicating a real appreciation of the currency and a potential loss of price competitiveness for domestic goods in international markets.
Incorrect Options
Statement 2 is incorrect. An increase in the REER indicates that domestic goods and services have become relatively more expensive compared to those of trading partners, after accounting for inflation. This makes exports less competitive and imports more attractive, thereby reducing trade competitiveness, not improving it.
Option (a) is incorrect because Statement 2 is incorrect.
Option (b) is incorrect because Statement 1 is correct, and Statement 2 is incorrect.
Option (d) is incorrect because Statement 2 is factually incorrect.