The latest update of The Big Mac index of economists for the beginning of 2021 shows that the rand is still one of the most undervalued currencies in the world.
In mid-2020, the local unit was found to be the most undervalued in the report, but started 2021 on a slightly better footing, thanks to global optimism over a Covid-19 vaccine and the end of the battle for the US Presidency.
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 idea that, in the long run, exchange rates should move towards the rate that would equalize the prices of the same basket of goods and services. (in this case, a Big Mac burger) in two countries.
The Big Mac is selected for comparison because the popular fast food meal is widely available around the world and remains fairly consistent in price; however, this is by no means an exact science.
According to The Economist, “Burgernomics” was never intended as a precise measure of monetary misalignment, but simply as a tool to make exchange rate theory more digestible.
The index has, however, become a global standard, included in several economics textbooks while also being the subject of at least 20 academic studies, the group noted.
The “ real ” value of the rand in January 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 R33.50 in South Africa and $ 5.66 in the United States. The implied exchange rate is € 5.42 for one dollar.
The difference between this rate and the real exchange rate – 15.52 rand to the dollar at the time of the report – suggests that the South African rand is undervalued by 61.9%, which is the fourth most undervalued currency. valued measured by the index in July.
The complete picture
However, the raw index does not tell the whole story of currency valuation.
Because many argue that due to PPPs, the cost of producing a Big Mac is cheaper in poor countries than in richer countries, The Economist takes another important indicator – GDP per capita – into account. draw a more precise conclusion.
In this adjusted index, the South African currency is still significantly undervalued, but less than when it comes to direct conversion data, which ranks sixth among undervalued, rather than most undervalued.
In PPP terms, a Big Mac costs 62% less in South Africa ($ 2.16) than in the United States ($ 5.66) at market exchange rates.
Based on the differences in GDP per person, a Big Mac should cost 44% less ($ 3.17). This suggests that the rand is 32.5% undervalued, and should be around R10.47 for a dollar.
Using this measure, the Russian ruble is the most undervalued currency in the world against the dollar (47.3% undervalued), followed by the Hong Kong dollar (46.8% undervalued).
Uruguay has the most overvalued currency at + 32.7%.
A currency is considered undervalued when its value in foreign currency is less 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 risk appetite, as well as a plethora of conditions (both local and global) that play into the stability of a market.
In the case of South Africa, the local economy is in recession, as many political and political issues make it a less attractive destination for foreign investment. Infrastructure failures, such as load shedding, also hamper development progress.
However, global markets have been dominated by the Covid-19 pandemic over the past year, while major events in base currency countries like the US presidential election and the Kingdom’s long Brexit saga United, have also weighed heavily on economies.
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