With reference to the Indian economy, consider the following statements: 1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee. 2. 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?

1. Correct. NEER is the weighted average of the rupee’s exchange rate against a basket of currencies; an increase in NEER generally means the rupee has appreciated in nominal terms.

2. Incorrect. REER adjusts NEER for inflation differentials. An increase in REER usually means the rupee is more overvalued in real terms, implying loss of trade competitiveness, not improvement.

3. Correct. If domestic inflation rises faster than inflation abroad, REER gets pushed up relative to NEER because REER incorporates price differentials while NEER does not; hence divergence can widen.

Therefore, statements 1 and 3 only are correct.