The ‘real’ value of the rand according to the Big Mac Index

The latest update to The Economists’ Big Mac Index shows that the South African rand is still undervalued – but a new metric used by the index implies that it may not be as bad as initially thought.

The Big Mac Index is an initiative created by The Economist that aims to measure whether currencies are priced 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 – using raw, direct conversion methods – South Africa has one of the most undervalued currencies in the world, where at July 2017, it was undervalued by 57.3%.

In the US, a Big Mac sells for $5.30 on average in 2017 – in South Africa the R30 price is equivalent to $2.26.

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 R13.05 to the dollar, the ‘burgernomics’ assessment says it should actually be R5.66.

This is up from the ‘fair value’ exchange rate of R5.20 back in January.

However, because many argue that, due to PPP, the cost to produce a Big Mac is cheaper in poorer countries than in richer ones, The Economist has also included an ‘adjusted price’ index in its July update – which factors in another important indicator, GDP per capita, to draw a better conclusion.

In this index, South Africa’s currency still remains heavily undervalued, but less so than when dealing with the straight conversion data.

When taking GDP per capita into account, the rand is 27.6% undervalued, according to the Big Mac Index, and should be trading closer to R9.61 than the R13.27 exchange in June.

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.

In South Africa’s case, we have stagnating economic growth and many political and policy issues that make it a more undesirable destination for foreign investment.

Read: The rand is massively undervalued according to the Big Mac index

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The ‘real’ value of the rand according to the Big Mac Index