Real Effective Exchange Rate

The real effective exchange rate (REER) measures a currency’s value against a trade-weighted basket of partner currencies after adjusting for relative prices or costs. A REER depreciation means domestic goods become relatively cheaper than foreign goods, other things remaining equal, thereby improving price competitiveness.

How depreciation supports exports

REER depreciation changes relative prices in favour of domestically produced goods and can redirect both foreign and domestic demand towards them.

• Exporters may reduce their foreign-currency prices, making exports more competitive and increasing export volumes.
• Alternatively, exporters may retain foreign-currency prices and receive higher domestic-currency margins, which can encourage production and market expansion.
• The effect is stronger when foreign demand is price-elastic and domestic firms possess sufficient supply capacity to meet additional orders.

Why the gain may be limited or delayed

Depreciation does not automatically produce a sustained rise in exports or an improvement in the trade balance.

• Existing contracts, invoicing practices and slow quantity adjustment may initially weaken the trade balance, producing a J-curve effect.
• A trade-balance improvement generally requires the combined responsiveness of export and import volumes to satisfy the Marshall-Lerner condition.
• Depreciation raises the domestic cost of imported fuel, machinery and intermediate inputs; this can reduce exporters’ cost advantage.
• Domestic inflation and exchange-rate pass-through can erode the initial REER depreciation by raising domestic prices.
• Weak infrastructure, unreliable logistics, poor quality or non-tariff barriers can prevent firms from converting price competitiveness into higher exports.

Policy significance

REER depreciation improves price competitiveness, but it does not by itself raise productivity or product quality. Durable export performance therefore requires structural reforms that improve technology, skills, logistics, trade facilitation and firms’ ability to enter global value chains.