The Economist updated its Big Mac Index, showing how the rand continues to be one of the most undervalued currencies in the world, against the US dollar.
The Big Mac Index is an initiative created by The Economist that aims to measure whether currencies are valued at their “correct” level.
It is based on the theory of purchasing power parity (PPP) – the notion that, in the long run, exchange rates should move towards the rate that would equalize the prices of an identical basket of goods and services. (in this case, a Big Mac burger) in two countries.
The Big Mac is selected for comparison as the popular fast food meal is widely available and remains fairly consistent in price; however, this is by no means an exact measurement.
According to The Economist, “Burgernomics” was never intended as an accurate indicator of monetary misalignment, but is simply a tool to make exchange rate theory more digestible.
The index has, however, become a global standard, included in several economics textbooks, and is also the subject of at least 20 academic studies, the group noted.
The “real” value of the rand in July 2021
The Big Mac Index measures the real value of currencies using two methods: a direct measure of PPP using gross prices, and an adjusted index that takes into account local GDP data.
Using raw data, a Big Mac costs Rand 33.50 in South Africa and $ 5.65 in the United States. the the implied exchange rate is R 5.93 per dollar.
The difference between that and the real exchange rate – 14.66 rand to the dollar at the time of reporting – suggests that the rand is undervalued by 59.5%, which is the third most undervalued currency measured by l index in July.
Local unity ranks only above the Russian ruble and the Lebanese pound, which are undervalued by 59.9% and 70.2%, respectively – although The Economist noted that Lebanon did not of Bic Mac comparable to compare, using the Maharaja. Mac instead.
GDP per capita
However, the raw index does not tell the whole story of currency valuation.
Because many argue that, due to PPP, the cost of producing a Big Mac is cheaper in poorer countries, The Economist takes into account another important indicator – GDP per capita – to draw a larger conclusion. precise.
“It should be emphasized that it is common for poor countries to look cheap compared to rich in a simple price comparison,” The Economist said, noting that in most countries, “the price of a burger is equal to what you would expect, given the country’s GDP per capita ”.
In the group’s adjusted index, the South African currency is still significantly undervalued (7th), but less than when it comes to simple conversion data.
In PPP terms, a Big Mac costs 59.2% less in South Africa ($ 2.28) than in the United States ($ 5.65) at market exchange rates.
Based on the differences in GDP per person, the index suggests that the rand is undervalued by 29.6% and should be around R10.32 to the dollar.
Using this measure, the Hong Kong dollar is the most undervalued currency against the US dollar, by up to 45.7%. That’s lower than the Taiwan dollar and Russian ruble, which are undervalued by 38.9% and 34.3%, respectively.
Adjusted for GDP per capita, Uruguay has the most overvalued currency at + 38.7%.
A currency is considered undervalued when its value in foreign currency is lower than what it “should” be based on economic conditions.
However, the value of the currency is not determined objectively and may be undervalued due to lack of demand, even if a country’s economy is strong.
Other factors are also taken into account, including investor appetite for risk, as well as a plethora of conditions, local and global, that affect the stability of a particular market.
In the case of South Africa, struggles in the local economy are well documented and have been going on for some time. This fuels a larger and protracted narrative of the decline of the South African economy, which fuels investor sentiment.
Global markets have been tainted by the ongoing Covid-19 pandemic, but in places like South Africa where vaccination strategies have faltered and coffers have been looted, these global problems are exacerbated.
More recently, riots and violence in KwaZulu Natal and parts of Gauteng have contributed to this destructive narrative, with economists and the South African Reserve Bank warning that the effects of unrest will continue to be felt in the economy for a while. time.
Read: Reserve Bank keeps repo on hold, but warns of impact of unrest on growth and investor confidence