Euro to top REER weight

The euro will have the maximum weight in the Reserve Bank of India's (RBI) proposed real effective exchange rate (REER) index, pushing the US dollar to the second position.

The RBI is planning to replace the the current five-country REER index with a six-country index. The Chineese yuan and Hong Kong dollar will be the new additions to the index.

The euro will replace the French Franc and Deustche Mark - the two European currencies that gave way to the euro when the entire Europe became one currency zone.

RBI Governor Y V Reddy had announced that the currencies in the new basket will include euro (EUR), US dollar (USD), British pound (GBP), Chineese yuan (CNY), Hong Kong dollar (HKD) and Japaneese yen (JPY).
 

Gaining Currency Trade weight for real effective exchange rate
Currency	Five-country  (current)	Six-country  (new)
USD	38.71	29.18
EUR	N.A.	35.74
GBP	16.56	11.44
CNY	N.A.	7.30
HKD	N.A.	7.85
JPY	18.72	8.49
FRF	6.32	N.A.
DEM	19.69	N.A.
Source: CEIC, Bank of America estimates

Analysts opined that they expect the current REER methodology to remain intact, with only a minor change in currency weights.

"The new index points to over-valuation of less than two per cent, a major decline form the eight per cent suggested by the present REER," an analyst said.

The US dollar had the largest trade weight in the current REER index at 38.71 per cent. GBP has a weight of 16.56 per cent and JPY has 18.72 per cent.

The franc and Deustche mark have a combined trade weight of 26.01. But in the revised index, the euro has the largest trade weight of 35.74 per cent, while the weight of US dollar will be reduced to 29.18 per cent.

The trade weight of GBP will reduce from 16.56 per cent to 11.44 per cent and JPY from 18.72 per cent to 8.49 per cent. The newly included Chineese yuan will have a weight of 7.3 per cent and the Hong Kong Dollar 7.85 per cent.

According to a recent currency strategy report of Bank of America, the REER revision is largely technical in nature. "The inclusion of CNY and HKD is nevertheless a notable development as it reflects India's increasing integration with Asia," the report said.

The inclusion of CNY would reduce the perceived overvaluation of the Indian rupee in the short run and create more room for the Indian rupee to appreciate along with CNY, over a long term.