The Economist has updated its Big Mac Index for mid-2022, 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 mid-2022
The Big Mac Index measures the real value of currencies by citing 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 R39.90 in South Africa and $5.15 in the United States. The implied exchange rate is R7.75 to the dollar.
The difference between this and the actual exchange rate – R17.04 to the dollar at the time of the report – suggests that the rand is undervalued by 54.5%, which is the fourth-most undervalued currency measured by the index in July.
The most undervalued currencies by this measure are the Venezuelan bolívar and the Romanian leu, which are undervalued by 65.8% and 55.7%, respectively. Russia has historically ranked as having one of the most undervalued currencies, but the war in Ukraine has caused McDonald’s to pull out of the country, leaving no comparison point.
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 (5th), but slightly less so than when dealing with straight conversion data.
In PPP terms, a Big Mac costs 54.5% less in South Africa (US$2.34) than in the United States (US$5.15) at market exchange rates. Based on differences in GDP per person, a Big Mac should cost 21.4% less.
Based on differences in GDP per person, the index suggests the rand is 42.2% undervalued and should be at around R9.85 to the dollar.
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, several economists in recent weeks have noted that the rand is being undervalued in markets, particularly as the currency’s weakness is being driven by international factors such as steep interest hikes in the US, and general fallout from the war in Ukraine.
The South African Reserve Bank last week announced a surprise 75 basis point hike in local rates, taking the lead from major economies. The hike cycle is set to continue with economists forecasting a further 100-125bp hike in rates by the end of the year.