The latest update to the Big Mac Index shows that South Africa’s currency remains one of the most undervalued in the world – and should be trading at R5.85 to the dollar.
The Big Mac index is one initiative, created by The Economist, that aims to measure whether currencies are 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 Bic Mac is selected for comparison as the popular fast-food meal is widely available across the world, and remains fairly consistent in pricing; however, it is by no means an exact science.
“Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible,” The Economist said.
The index has however, become a global standard, included in several economic textbooks while also becoming the subject of at least 20 academic studies, the group noted.
The “real” value of the rand
Big Mac Index – July 2016
In the USA, a Big Mac sells for $5.04 on average in 2016 – in South Africa the price is $2.04 (R29.50).
This means that a South African in the USA would expect to pay R72.79 for the same product that costs R29.50 locally.
In order to reach pricing parity, the value of the South African currency would have to sit at R5.85 to the dollar.
This shows that the rand is undervalued by 59%.
According to 2015 data by the World Bank, the rand’s PPP value to the dollar is at a similar level at R5.52, giving credence to the rudimentary measure from the Big Mac Index.
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.
According to the index, South Africa has one of the most under-valued currencies in the world by this measure. Switzerland and Norway, on the other hand, have over-valued currencies (the former by as much as 30%).
The data suggests that the dollar itself may be over-valued, however the publication points out that rates tend to look cheap – in developing countries in particular – due to poor productivity.
South Africa’s productivity has literally flat-lined, with the South African Reserve Bank setting the GDP growth prospects for 2016 at 0%.
More on the rand
Rand recovers after being dented by IMF corruption and growth concerns
Zuma will send rand to R17 to the dollar: analyst