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

The Economist has updated its Big Mac Index for mid-2023, showing that the rand is more undervalued against the dollar than at the start of the year.

The local unit has had a rough week, losing around 5% of its value against the dollar by Friday (4 August). This follows a week where the rand was singing – along with other emerging markets – due to a risk-on environment globally.

According to economists from the Bureau for Economic Research (BER), the wild swing came because of a shock downgrade to the United States’ credit rating by Fitch amid weaker economic data from China, which quickly put investors into a very risk-averse mindset.

With the rand now trading at R18.50 to the dollar, the currency is again in dangerous territory. However, this is not the ‘true’ value of the rand, according to The Big Mac Index.

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 mid-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$5.58 in the United States. The implied exchange rate is R8.94.

The difference between this and the actual exchange rate – R17.78 at the time the data was compiled – suggests the South African rand is 49.7% undervalued, the 5th most undervalued currency in the analysis.

Based on current exchange rates, the rand is 51.7% undervalued.

Notably, this is more undervalued than at the start of the year, when the rand was the 11th most undervalued currency at the time. This suggests the rand is moving further away from its ‘real’ value in terms of actual purchasing power.

The most undervalued currencies by this measure are the Taiwanese dollar and the Indonesian rupiah, which are undervalued by 57.2% and 54.8% versus the dollar, respectively. On the other end of the spectrum, the Swiss franc and Norwegian krone are currently the most overvalued, at +38.5% and +24.0%, 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 undervalued, but only the seventh most undervalued.

In PPP terms, a Big Mac costs 49.7% less in South Africa (US$2.81) than in the United States (US$5.58) at market exchange rates. Based on differences in GDP per capita, a Big Mac should cost 17.5% less (ie, $4.60).

Based on differences in GDP per capita, the index suggests the rand is 36.4% undervalued and should be at around R10.85 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 carries a hefty risk premium – given the country’s ongoing power crisis and permanent load shedding, it’s a difficulty prospect for any investor to safely put money into the country and expect growth.

The economy has stagnated and is barely expected to post a positive growth number in 2023 – with even the most optimistic scenarios pointing to flat growth over the next few years.

On top of the headline issues, South Africa also carries risk on the sociopolitical front, with the 2024 elections looming, the national government leaning heavily into growth-destroying populist policies, while also playing with fire in its geopolitical positioning relating to the West and Russia.

Given the current state of the country, it should be no surprise that the rand is trading on the weaker end against the dollar – with its prospects looking cloudy even in the best-case scenarios.

Read: This is what the rand should be valued at – and where it’s more likely to go