05 Aug The Big Mac Index Says the Rand is Way Undervalued
“Our results indicate that the Big Mac Index is surprisingly accurate in tracking exchange rates over the long-term, which is consistent with previous PPP research findings” (ScienceDirect)
For decades the Economist has been publishing its Big Mac Index to give an estimation of how under- or over-valued a currency is. This is done by comparing the price of a MacDonalds Big Mac Burger in a country to the price of the burger in the USA.
Although this began as a lighthearted attempt to establish currency values, it has gained traction and credibility.
Purchasing Power Parity (PPP)
It is a tenet of economic theory that over time currencies will equate to the cost of goods and services in other countries. Thus, if a basket of goods and services costs, say, $20 in the USA and costs R100 in South Africa, then the Rand to US dollar rate should equal R5 to 1 US$.
The Big Mac Index
The cost of a Big Mac is $5.74 in the U.S. whilst the cost in South Africa is R31 which translates into the PPP rate of US$1 = R5.40. As the actual rate at the time the index was measured was R14.18 to the dollar, so the Rand is 61.9% undervalued (14.18-5.5/14.18).
How do we compare worldwide?
The Economist looks at approximately 60 countries in compiling its index and we rank as the third most undervalued currency, ahead only of Malaysia and Russia.
Whilst some will dismiss the Big Mac index, it does underline that South Africa faces many headwinds with a potential downgrade to full junk status (Moodys is expected to announce its decision on South Africa’s debt in October after the Medium Term Budget), a stalled economy and uncertainty as to how to re-ignite economic growth. As economic growth is dependent on investment another key issue is how to make South Africa an attractive place to invest.