The ‘real’ value of the rand in 2023, according to the Big Mac Index
The Economist has updated its Big Mac Index for 2023, showing that the rand is still undervalued against the US dollar – but it’s trading closer to its ‘real’ value than in 2022.
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 to be a precise gauge of currency misalignment but merely a tool to make exchange-rate theory more digestible.
However, the group noted that the index has become a global standard, included in several economic textbooks, and is also the subject of at least 20 academic studies.
The ‘real’ value of the rand in 2023
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 considers local GDP data.
Using the raw data, a Big Mac costs R49.90 in South Africa and US$5.36 in the United States. The implied exchange rate is R9.31.
The difference between this and the actual exchange rate, R17.21, suggests the South African rand is 45.9% undervalued, the 11th most undervalued currency in the analysis.
Notably, this is very different from mid-2022, when the rand was the fourth most undervalued currency at the time. This suggests the rand is closer to its “real” value in global markets right now, despite being weaker than in June 2022, when it was trading at R17.04 to the dollar.
The most undervalued currencies by this measure are the Egyptian pound and the Indonesian rupiah, which are undervalued by 65.6% and 56.6% versus the dollar, respectively. On the other end of the spectrum, the Swiss franc and Uruguayan peso are currently the most overvalued, at +35.4% and +27.8%, respectively.
GDP per capita
One of the bigger flaws of the Big Mac index is that it doesn’t take the full picture into account when evaluating currency differences.
Experts have argued that because of PPP, the cost to produce a Big Mac is typically cheaper in poorer countries, thus skewing the data.
To account for this, The Economist produces a parallel index that factors in the GDP per capita of a country to draw a more accurate conclusion.
In the group’s adjusted index, South Africa’s currency is still the 11th most undervalued.
In PPP terms, a Big Mac costs 45.9% less in South Africa (US$2.90) than in the United States (US$5.36) at market exchange rates. Based on differences in GDP per capita, a Big Mac should cost 14.9% less (ie, $4.56).
Based on differences in GDP per capita, the index suggests the rand is 36.4% undervalued and should be at around R10.94 to the dollar.
Under-valued?
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 and a plethora of local and global conditions that play into a particular market’s stability.
In South Africa’s case, the rand is under pressure on several key fronts: the unit is at the mercy of global market movements, particularly that of the US dollar – meanwhile, local conditions, such as the ongoing energy crisis and persistent load shedding, weigh heavily on sentiment.
Looking at international markets, the rand strengthens and weakens based on risk sentiment. When investors see global markets as being risky, they flood into safe haven currencies like the US dollar. When tensions ease, they’re more willing to put money into riskier and more volatile currencies like the rand.
According to economists, this is the biggest driver of the rand’s value. While load shedding and Eskom’s power crisis have a dire impact on South Africans and local businesses, the country’s woes in this regard have been largely priced into the market for many years.
That does not mean they are discounted, however. With load shedding hitting the worst levels on record and institutions like the South African Reserve Bank expecting worse to come in 2023, the outages will undoubtedly weigh heavily on the rand this year.
According to private banking group Investec, some of the factors playing into the rand’s value include: local economic growth; global risk sentiment; credit ratings; weather patterns; inflation; energy transition; the load shedding crisis; governance and policy issues; and the looming greylisting.
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