Real effective exchange rate is released by RBI on monthly basis, which is determined to be a valuation for Indian currency in terms of other foreign currencies. REER value is determined in terms of consumer price index (CPI) and whole sale price (WPI). But by 2014, India has decided to evaluate the REER only in terms of CPI.Current CPI evaluation of India indicates the differences that occur in inflation for every period that would be held as a foundation to calculate REER effectively. REER helps an economy to decide on its competitiveness in terms of other currencies. REER will be usually evaluated in terms of 6 currency basket and 36 currency baskets also in trade weighted and export weighted methodology.
Now let us see now REER can be interpreted as – Say for example REER is 107%, it means that Rupee is overvalued by 7% (i.e) if USD/INR rate is Rs.64, its original value would be 7% less than the spot value somewhere around Rs.68 (approximately). Similarly, if REER is evaluated to be 95% it means that rupee is undervalued by 5% so a fair chance exist for the USD/INR value to reduce by 5%. REER is generally calculated with the exchange rate and CPI values of both the currencies that occur in currency pair. USD/INR = Rs.64 is a currency pair where USD is the base currency and INR is the dependent currency which represents 1 USD = 64INR.
With reference to REER economy’s movements can be predicted, say for example if RBI releases REER value to be around 95% which means that rupee value would appreciate and dollar depreciates, though it is good to Indian economy foreign investors would face a bad luck which may lead them to withdraw money from Indian economy as a step towards prevention. Also undervaluation of currency would flash a ray of bad luck to exporters as their return would decrease but an enlighten factor for importers as they can expect the rate to become flexible. If REER is estimated to be 100% it literally means that spot price is evaluated properly and USD/INR deserves the current market price.