Explanation:

Real effective exchange rate is defined as “a weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries, relates to the purchasing power parity (PPP) hypothesis”. As the definition highlights, REER takes price differential and inflation into account and, therefore, is said to be a better indicator of the competitiveness of the country in terms of exchange rates. In India, Reserve Bank of India (RBI) complies with REER indices. The first one is based on six country’s trade-based weights and the second on 36-currencies’ export and trade-based weights. The indices are also a better reflection of the position of a currency in comparison with the countries in which India has large export and trade interest. The base is taken as100 and currently the base year is 2004-2005. A rise in the level of index indicates appreciation of currency and vice- versa. Even though rising and falling currency means different things to different people, economists insist that people should not look at the movement of nominal rates and focus on real effective exchange rate (REER).