The latest update of The Economists’ Big Mac Index for mid-2020 shows that the rand is currently the most undervalued currency in the world.
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, over the long term, exchange rates should approach 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 because the popular fast food meal is widely available around the world and remains fairly consistent in price; however, it is by no means an exact science.
According to The Economist, “Burgernomics” was never intended as an accurate 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 “true” value of the rand in July 2020
The Big Mac Index measures the real value of currencies using two methods: a direct measure of PPP using raw prices and an adjusted index that takes local GDP data into account.
Using the raw data, a Big Mac costs R31.00 in South Africa and $5.71 in the United States. The implied exchange rate is 5.43 rand per dollar.
The difference between this rate and the real exchange rate – 16.67 rand to the dollar – suggests that the South African rand is undervalued by 67.4%, which is the most undervalued currency measured by the index in July.
The full picture
However, the raw index does not tell the whole story of currency valuation.
Because many argue that because of PPP, the cost of producing a Big Mac is cheaper in poorer countries than in richer ones, The Economist takes into account another important indicator – GDP per inhabitant – to draw a more accurate conclusion.
In this adjusted index, the South African currency still remains heavily undervalued, but less than when it comes to direct conversion data, ranked as the third most undervalued currency, rather than the most undervalued. assessed.
In PPP terms, a Big Mac costs 67% less in South Africa ($1.86) than in the United States ($5.71) at market exchange rates.
Based on differences in GDP per person, a Big Mac should cost 44% less ($3.19). This suggests that the rand is 41.3% undervaluedand should be at 9.32 rand per dollar.
By this measure, the Hong Kong dollar is the most undervalued currency in the world against the dollar (undervalued by 47.7%), followed by Russia (undervalued by 43.6%).
Thailand has the most overvalued currency at +26.7%.
A currency is considered undervalued when its value in foreign currency is lower than it “should” be based on economic conditions.
However, the value of currency is not determined objectively and can be undervalued due to a lack of demand, even if a country’s economy is strong.
Other factors are also taken into account, such as investors’ appetite for risk, as well as the plethora of conditions (both local and global) that affect the stability of a market.
In the case of South Africa, the local economy is in recession, while numerous political problems make it a less desirable destination for foreign investment. Infrastructure outages, such as load shedding, also hamper development progress.
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