The Economist has updated its Big Mac Index, showing how the rand continues to be one of the most undervalued currencies globally, relative to the US dollar.
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, and remains fairly consistent in pricing; however, it is by no means an exact measure.
According to The Economist, ‘Burgernomics’ was never intended as a precise gauge of currency misalignment, but is merely a tool to make exchange-rate theory more digestible.
The index has, however, become a global standard, included in several economic textbooks, and is also the subject of at least 20 academic studies, the group noted.
The ‘real’ value of the rand in July 2021
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 into account local GDP data.
Using the raw data, a Big Mac costs R33.50 in South Africa and $5.65 in the United States. The implied exchange rate is R5.93 to the dollar.
The difference between this and the actual exchange rate – R14.66 to the dollar at the time of the report – suggests that the rand is undervalued by 59.5%, which is the third most undervalued currency measured by the index in July.
The local unit ranks only above the Russian ruble and the Lebanese lira, which are undervalued by 59.9% and 70.2%, respectively – though The Economist noted that Lebanon doesn’t have a like-for-like Bic Mac to compare, using the Maharaja Mac instead.
GDP per capita
However, the raw index does not tell the full story of currency valuation.
Because many argue that, due to PPP, the cost to produce a Big Mac is cheaper in poorer countries, The Economist factors in another important indicator – GDP per capita – to draw a more accurate conclusion.
“It is worth pointing out that it is common for poor countries to seem cheap relative to rich ones in any simple comparison of prices,” The Economist said, noting that in most countries, “the price of a burger is about what you would expect given the country’s GDP per person”.
In the group’s adjusted index, South Africa’s currency still remains heavily undervalued (7th), but less so than when dealing with straight conversion data.
In PPP terms, a Big Mac costs 59.2% less in South Africa ($2.28) than in the United States ($5.65) at market exchange rates.
Based on differences in GDP per person, the index suggests the rand is 29.6% undervalued and should be at around R10.32 to the dollar.
Using this measure, the Hong Kong dollar is the most undervalued currency relative to the US dollar, by as much as 45.7%. This is below the Taiwan dollar and Russian ruble, which are undervalued by 38.9% and 34.3%, respectively.
Adjusted for GDP per capita, Uruguay has the most overvalued currency at +38.7%.
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, including investors’ appetite for risk, as well as a plethora of conditions, local and global, that play into the stability of a particular market.
In South Africa’s case, the struggles in the local economy are well documented and have persisted for some time. This feeds into a wider and prolonged narrative of South Africa’s economy being in decline, which feeds into investor sentiments.
Global markets have been marred by the ongoing Covid-19 pandemic, but in places like South Africa where vaccination strategies have faltered, and coffers have been looted, these global issues are exacerbated.
More recently, riots and violence in KwaZulu Natal and parts of Gauteng have contributed to this destructive narrative, with economists and the South African Reserve Bank warning that the effects of the unrest will be still felt in the economy for some time.