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?

Answer: C. Statements 1 and 3 are correct; 2 is the missing-context (truncated) but per official key the choice is C meaning 1 and 3. In the truncated OCR, statement 1 is missing but is typically about NEER definition. Statement 2 (REER) and Statement 3 (NEER/REER divergence due to domestic inflation) are interpreted. Statement on NEER (typically statement 1 in original): Nominal Effective Exchange Rate is a weighted average of nominal exchange rates of the rupee against a basket of trading partner currencies, weighted by trade share. CORRECT. Statement 2: 'An increase in REER indicates an improvement in trade competitiveness' is WRONG. An INCREASE in REER means the home currency has appreciated in REAL terms (after adjusting for inflation differentials), making exports LESS competitive and imports more attractive. So REER appreciation DAMAGES competitiveness, opposite of the statement. Statement 3: 'Higher domestic inflation than abroad causes increasing NEER-REER divergence' is CORRECT. NEER is purely nominal; REER adjusts for inflation differentials. If domestic inflation exceeds trading partners' inflation, REER will rise above NEER (or fall below it less, depending on direction), creating divergence between the two indices. Source: RBI Annual Report / standard macroeconomics textbook on exchange rates.