The Economist has published its Big Mac Index for 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 2022
The Big Mac Index measures the real value of currencies 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 $5.81 in the United States.
The implied exchange rate is R6.87 to the dollar.
The difference between this and the actual exchange rate – R15.47 to the dollar at the time of the report – suggests that the rand is undervalued by 55.6%, which is the eighth-most undervalued currency measured by the index in February.
The most undervalued currency by this measure is the Russian ruble and the Turkish lira, which are undervalued by 70.0% and 67.9%, respectively. South Africa was the third most undervalued currency in 2021, but nations such as Indonesia, Malaysia, Romania, Ukraine and India have since become even more undervalued versus the dollar.
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 (11th), but less so than when dealing with straight conversion data.
In PPP terms, a Big Mac costs 55.6% less in South Africa ($2.58) than in the United States ($5.81) at market exchange rates.
Based on differences in GDP per person, the index suggests the rand is 25.5% undervalued and should be at around R11.52 to the dollar.
Using this measure, the Russian ruble is still the most undervalued currency relative to the US dollar, by as much as 52.1%. This is below the Hong Kong dollar and Turkish lira, which are undervalued by 45.0% and 48.0%, respectively.
Adjusted for GDP per capita, Uruguay has the most overvalued currency at +39.8%.
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, as well as a plethora of conditions, local and global, that play into the stability of a particular market.
In South Africa’s case, the struggles in the local economy are well documented and have persisted for some time. This feeds into a wider and prolonged narrative of South Africa’s economy being in decline, which feeds into investor sentiments.
Global markets have been marred by the ongoing Covid-19 pandemic, but in places like South Africa where vaccination strategies have faltered, and coffers have been looted, these global issues are exacerbated.
More recently, the local market has been lifted by over-performance in the mining and commodities sector versus expectations; however, corruption, load shedding and fallout from social unrest in 2021 keep sentiment tempered in the country.
https://businesstech.co.za/news/trending/555730/the-real-value-of-the-rand-in-2022-according-to-the-big-mac-index/
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