Why in News? Between April-end 2014 and now, the rupee has depreciated by 27.6% against the US dollar (from Rs 60.34 to Rs 83.38), which is slightly higher than 26.5% (from 44.37 to 60.34) between April-end 2004 and April-end 2014.

How is the Strength or Weakness of the Rupee Decided? It is a function of its exchange rate with not just the US dollar, but also with other global currencies. In this case, it would be against a basket of currencies of the country’s most important trading partners - what is called the rupee’s effective exchange rate (EER).

How are Currency Weights Decided for Calculating EER? Similar to how the weights for each commodity in the Consumer Price Index (CPI) are determined by their relative importance within the overall consumer basket, the currency weights are determined by the respective countries' share of India's total foreign trade.

What are the Two Measures of EER?

1. Nominal EER (NEER): The RBI has constructed NEER indices of the rupee against a basket of six (US dollar, euro, Chinese yuan, British pound, Japanese yen and Hong Kong dollar) and also of 40 currencies (that account for about 88% of India’s annual trade flows). The NEER indices are with reference to a base year value of 100 for 2015-16.
2. Real EER (REER): It is basically the NEER that is adjusted for the inflation differentials between the home country and its trading partners. Any increase in REER means that the costs of exports from India are rising more than the prices of imports into the country. That translates into a loss of trade competitiveness.

What the NEER and REER Data Shows About Rupee Depreciation?  The rupee has strengthened in real terms over time. This is opposite to the trend of weakening of rupee’s NEER or its exchange rate with the US dollar. If a country’s nominal exchange rate falls less than its domestic inflation rate - as with India - the currency has actually appreciated in “real” terms.