South Africa’s currency is largely undervalued and should be trading at closer to R5.30 against the dollar, than R12, the Big Mac Index shows.
This is against a backdrop of the rand’s weakness over the past few weeks, with the currency pushing record lows against the greenback.
The Big Mac index is one initiative, created by The Economist, that aims to measure whether currencies are 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 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.
“Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible,” The Economist said.
The index has however, become a global standard, included in several economic textbooks while also becoming the subject of at least 20 academic studies, the group noted.
South Africa’s “real” currency value
In the USA, a Big Mac sells for $4.79 as of January 2015 – in South Africa the price is $2.13 (R25.50).
This means that a South African in the USA would expect to pay R57.46 for the same product that costs R25.50 locally.
In order to reach pricing parity, the value of the South African currency would have to sit at R5.32 to the dollar.
This shows that the rand is undervalued by 57%.
Data from the World Bank points to similar PPP values, showing that between 2010 and 2014, South Africa’s currency carried an average PPP trade value of R5.11 when purchasing its selected basket of goods.
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.
“The difference between the price predicted by the red line for each country, given its income per person, and its actual price gives a supersized measure of currency under- and over-valuation,” it said.
According to the World bank, South Africa has a GDP per capita of $12,506.70 (in international or PPP dollars), versus the US GDP per capita of $53,042.00.
Most undervalued currencies in the world (PPP – Big Mac Index)
|Country||Big Mac price (US$)||Undervalued by|
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, however, and may be undervalued due to a lack of demand, even if a country’s economy is strong.
According to South African economists, South Africa’s economy is not strong, though. The country is currently in an extended phase of slowed economic growth and a widening trade deficit – all the while juggling a power crisis and number of labour-related social issues.