CPI, NEER and REER TIMOR LESTE WITH TRADING PARTNER

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The price of one currency in terms of another is called exchange rate. Exchange rates play a central role in international trade because they allow the computation of the relative prices of goods and services produced in different countries thereby allowing the comparison of those prices across countries. Changes in exchange rates are described either as depreciations or appreciations. Real exchange rates are nominal exchange rates corrected somehow by the effect of price movements (increase or decrease) in the economy. Real exchange rates are defined in terms of nominal exchange rates and price levels. The real exchange rate provides information on the degree of competitiveness of one country when compared to another. For example, the real exchange of the US dollar against the Indonesian rupiah provides information on the competitiveness of the Timorese economy compared to Indonesia. In this case, a decline in the real dollar/rupiah exchange rate (which is called a real appreciation of the dollar against the rupiah) would mean a decline in the purchasing power of the rupiah in Timor Leste and therefore a loss in competitiveness for Timor Leste vis-à-vis Indonesia.  Conversely, an increase in real dollar/rupiah exchange rate (called real depreciation of the dollar against the rupiah) would mean an increase in the purchasing power of the rupiah in Timor Leste and therefore a gain in competitiveness for Timor Leste vis-à-vis Indonesia.

The indicator to measure exchange rate changes is the Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER).

The NEER is a weighted average of major bilateral nominal exchange rates, with weights based on the trade shares reflecting the relative importance of each currency in the effective exchange rate basket. The REER is obtained by adjusting the NEER for inflation differentials with the countries whose currencies are included in the basket. As the inflation rate in each country is assumed to broadly indicate the trends in domestic cost of production, the REER is expected to reflect foreign competitiveness of domestic products. The main focus of the REER is on the trade balance, particularly on the exchange rate induced changes in trade flows. A trend appreciation of the real effective exchange rate is considered unfavorable for the growth of exports and as it favors imports from competing countries.

The graph of RER TL vis a vis Indonesia and Australia reveal the current situation with trading partners

Calculation, Sources and Methodology

The NEER and REER based on trade composition with 8 trading partner countries are computed on a regular basis by the Banking and Payments Authority (BPA).

The NEER for each time period t is defined as the weighted sum of the bilateral nominal exchange rates, with weights defined as share of external trade of each trade partner on total.

Where       : Exchange rates of country/currency i against the US dollar

                  : Weights attached to the country/ currency i in the index

The REER is the weighted sum of bilateral real exchange rates, with weights given by the share of each trading partner total:

j = Timor-Leste , i=partner

Selection of countries in the basket is based on bilateral trade shares and the importance in terms of competitiveness of those countries import to Timor-Leste in the international market.

Currencies selected for the trading partner are; Thailand bath, Indonesia Rupiah, Portugal Euro, Malaysian Ringgit, Singapore Dollar, Japanese Yen, and Australian Dollar. The exchange rate of each country is collected from the official reference rate released by Bloomberg website, except Vietnamese Dong by Oanda, which is equal to a monthly average of actual exchange rate.

The weighted value is calculated on basis of geometric average of Timor-Leste bilateral trade with each of the countries.

Trading composition (2001=100) percent: Indonesia is 57, Australia 21, Singapore 16, Portugal 4 and Malaysia 2.

Start December 2006 the trading partner is changed to the following composition (percent): Indonesia 45, Australia 17, Singapore 17, Japan 7, Vietnam 5, Thailand 4, Malaysia 3 and Portugal 2.

The data source is from the National Statistics Department. If the current years weighted value necessary for computation is unavailable, hence, preliminary estimates are calculated using the weighted values of the previous year. After the current year trade data becomes available, the preliminary rates are revised.

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