The Economist’s Big Mac Index for 2016 shows how weak the rand has become – and how the currency theoretically remains one of the most ‘undervalued’ in the world.
South Africa’s currency hit a new low against the US dollar late on Sunday night, as Asian markets opened, hitting as low as R17.99 to the US dollar before pulling back to R17.25, and settling around R16.72 in trade on Monday (11 January).
The Big Mac Index 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 equalise the prices of an identical basket of goods and services (in this case, a Big Mac burger) in any two countries.
The Bic Mac is selected for comparison as the popular fast-food meal is widely available across the world, and remains fairly consistent in pricing – however, it is by no means an exact science.
According to The Economist, which publishes its “burgernomics” indicator each year, in terms of purchasing power parity, the rand should be trading at closer to R5.68 to the dollar.
In 2016, a Bic Mac in the USA sells for $4.93 – while the South African Big Mac (at R28.00) sells for an equivalent $1.77 (at R15.81/$ – used at the time of the study).
To reach pricing parity, the rand would have to be R5.68 to the dollar.
This “implied” exchange rate is a far stretch from the R15.81 used at the time of the study.
The difference, in theory at least, means that the rand is undervalued by 64%
At R16.72 to the dollar, the currency is undervalued by 66% in PPP terms – the lowest point in South Africa’s history on the index.
The table below shows the rand’s value from 2000 to 2016 relative to the US dollar in PPP terms using Bic Mac prices.
|Year||USD Big Mac (USD)||SA Big Mac (ZAR)||ZAR/USD Exchange Rate||SA Big Mac (USD)||ZAR/USD PPP||ZAR/USD Value|
This graph shows how the value of the rand has changed versus the US dollar since 2000, and how it has significantly diverged in its purchasing power value over that time.
The Bic Mac index is widely used to gauge the health of an economy. Its figures align closely with those of the World Bank and the International Monetary Fund.
A currency is considered undervalued when its value in foreign exchange is less than it “should be” based on economic conditions.
Currency value isn’t determined objectively, and may be undervalued due to a lack of demand, even if a country’s economy is strong. South Africa’s economy is not strong, however, described globally as one of the most fragile in the world.
According to The Economist, a fairer measure of a currency’s fair value would be to look at the relationship between prices and GDP per person, where South Africa has a GDP per capita of $13,046 (PPP dollars, World Bank, 2014) versus the USA’s $54,629.