The rand is massively undervalued according to the Big Mac Index

The latest Big Mac Index shows that South Africa’s currency remains one of the most undervalued in the world – currently trading at R13.55 to the dollar, when it should be less than half that.

The Big Mac index is an 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 Big 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.

According to the index, South Africa has one of the most undervalued currencies (62.7%) in the world.

In the US, a Big Mac sells for $5.04 on average in 2016 – in South Africa the price is $1.89.

This means that a South African in the US would expect to pay a lot more for the same product that would be less than half the price in their home country.

While the rand is currently trading at R13.55 to the dollar, the ‘burgernomics’ assessment says it should actually be R5.20.

A currency is considered undervalued when its value in foreign exchange is less than it “should” be based on economic conditions.

However, currency value isn’t determined objectively, and may be undervalued due to a lack of demand, even if a country’s economy is strong. Other factors are also taken into account, like investors’ appetite for risk, as we as the plethora of conditions (both locally and globally) that play into stability of a market.

Why we’re so undervalued

In South Africa’s case, the rand is one of the most volatile currencies globally (recently losing the ‘top honour’ to the Turkish lira), due to the sheer volume of economic conditions which push and pull it around.

These include:

• Being grouped with two different currency markets (emerging markets and commodity markets)
• The USA’s federal reserve rate normalisations (which has a global impact)
• China’s economic slowdown (which impacts demand for commodities)
• Rating agencies (which currently have the country on a negative outlook)
• Low business confidence
• Low growth projections
• Low tax collections
• Sentiment (which is currently carried by a sense of uncertainty)
• Political instability (which can influence policy direction)

All of these factors, and more, play a part in making the rand a volatile currency – providing ample opportunity to dip into “safe” investments when other markets shake, but not offering the stability of currencies that have stronger growth prospects.

Read: The rand could lose over 10% of its value by the end of 2017