September 20, 2021

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

The Economist has up to date its Big Mac Index, displaying how the rand continues to be one of the most undervalued currencies globally, relative to the US greenback.

The Big Mac Index is an initiative created by The Economist that goals to measure whether or not currencies are priced at their “correct” stage.

It’s based mostly on the concept of purchasing-power-parity (PPP) – the notion that, in the long term, trade charges ought to transfer in direction of the charge that will equalise the costs of an an identical basket of items and providers (on this case, a Big Mac burger) in any two international locations.

The Big Mac is chosen for comparability as the well-liked fast-food meal is extensively obtainable, and stays pretty constant in pricing; nonetheless, it’s on no account a precise measure.

According to The Economist, ‘Burgernomics’ was by no means supposed as a exact gauge of forex misalignment, however is merely a software to make exchange-rate concept extra digestible.

The index has, nonetheless, change into a world normal, included in a number of financial textbooks, and can be the topic of at the very least 20 tutorial research, the group famous.

The ‘real’ value of the rand in July 2021

The Big Mac Index measures the actual value of currencies utilizing two strategies – a direct measure of PPP utilizing uncooked costs, and an adjusted index that takes under consideration native GDP information.

Utilizing the uncooked information, a Big Mac prices R33.50 in South Africa and $5.65 in the United States. The implied trade charge is R5.93 to the greenback.

The distinction between this and the precise trade charge – R14.66 to the greenback at the time of the report – means that the rand is undervalued by 59.5%, which is the third most undervalued forex measured by the index in July.

The native unit ranks solely above the Russian ruble and the Lebanese lira, that are undervalued by 59.9% and 70.2%, respectively – although The Economist famous that Lebanon doesn’t have a like-for-like Bic Mac to examine, utilizing the Maharaja Mac as a substitute.

GDP per capita

Nevertheless, the uncooked index doesn’t inform the full story of forex valuation.

As a result of many argue that, due to PPP, the value to produce a Big Mac is cheaper in poorer international locations, The Economist elements in one other essential indicator – GDP per capita – to draw a extra correct 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 mentioned, noting that in most international locations, “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 forex nonetheless stays closely undervalued (seventh), however much less so than when coping with straight conversion information.

In PPP phrases, a Big Mac prices 59.2% much less in South Africa ($2.28) than in the United States ($5.65) at market trade charges.

Based mostly on variations in GDP per particular person, the index suggests the rand is 29.6% undervalued and ought to be at round R10.32 to the greenback.

Utilizing this measure, the Hong Kong greenback is the most undervalued forex relative to the US greenback, by as a lot as 45.7%. That is beneath the Taiwan greenback and Russian ruble, that are undervalued by 38.9% and 34.3%, respectively.

Adjusted for GDP per capita, Uruguay has the most overvalued forex at +38.7%.

Beneath-valued?

A forex is taken into account undervalued when its value in overseas trade is lower than it “should” be based mostly on financial circumstances.

Nevertheless, forex value isn’t decided objectively and could also be undervalued due to an absence of demand, even when a rustic’s financial system is robust.

Different elements are additionally taken under consideration, together with buyers’ urge for food for threat, in addition to a plethora of circumstances, native and world, that play into the stability of a specific market.

In South Africa’s case, the struggles in the native financial system are properly documented and have persevered for a while. This feeds right into a wider and extended narrative of South Africa’s financial system being in decline, which feeds into investor sentiments.

World markets have been marred by the ongoing Covid-19 pandemic, however in locations like South Africa the place vaccination methods have faltered, and coffers have been looted, these world points are exacerbated.

Extra lately, riots and violence in KwaZulu Natal and elements of Gauteng have contributed to this damaging narrative, with economists and the South African Reserve Financial institution warning that the results of the unrest will likely be nonetheless felt in the financial system for a while.


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