Pakistan’s Real Effective Exchange Rate (REER), a measure of the value of a currency against a weighted average of several foreign currencies, witnessed an increase as it clocked in at 91.72 in September 2023, up from 90.1 in August 2023, according to data released by the State Bank of Pakistan (SBP) on Thursday.
A REER index of 100 should not be misinterpreted as denoting the equilibrium value of the currency. 100 merely represents the value of the currency at a chosen point in time (in this case the average value of the currency in 2010). Therefore, the movement of the REER away from 100 simply reflects changes relative to its average value in 2010 and is unrelated to its equilibrium value.
As per the latest data by the SBP, the REER increased 1.86% month-on-month (MoM).
With its current account deficit (CAD) reaching an all-time high of $940.7 million in September 2023, which negatively impacted the foreign currency reserves and the balance of payments, nations like Pakistan benefit from a REER below 100.
Appreciation (depreciation) of REER is sometimes confused with the concept of currency overvaluation (undervaluation) while these are two separate concepts and not necessarily interpreted in the same direction. For an assessment of a country’s exchange rate misalignment, a more sophisticated analysis is required taking into account factors such as demographics, external and fiscal sustainability, and some other macroeconomic fundamentals over the medium-term.
In March this year, the central bank had been (compiling and) publishing data on NEER and REER indices (base: 2010=100) through the website on monthly basis regularly. The indices are computed against the basket of countries constituting our major trading partners/competitors using weights as estimated by IMF periodically. It is a dynamic concept as trading partners/competitors, and their respective weights, for different countries, can change overtime and Pakistan is no exception.
IMF estimates the weights of trading partners/competitors for its member countries utilizing access to extensive datasets needed for calculating such weights1. The weights and trading partners are revised by IMF periodically as a routine exercise. The weights are calculated as three year averages using annual data on merchandise trade, manufacturing, and tourism of trading partners/competitors. The last revision for updating the list of trading partners and their respective weights was carried out in 20192 when weights based on 2013-15 data were estimated.
What is REER?
According to the central bank, REER is an indicator that compares the cost of a nation’s key trading partners’ products to the cost of the same basket in that country.
The prices of these baskets, with each trade partner’s nominal exchange rate applied, are expressed in the same currency. According to the SBP website, each trading partner's basket price is determined by how much of its share is made up of imports, exports, or overall international trade.
