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Big Mac Index: Rand should be trading at R5.63/$

Jul 18 2018 06:45
Marelise van der Merwe

The South African rand is undervalued against the dollar by as much as 57.9%, suggests the latest Big Mac Index, released annually by The Economist.

First produced in 1986 "as a lighthearted guide to whether currencies are at their 'correct' level", the index uses purchasing-power parity – or the notion that in the long run, exchange rates should move towards a rate that would equalise the prices of identical goods and services in any two countries – to evaluate currencies' relative value.

The resultant system, or "burgernomics", has been updated regularly ever since.

A Big Mac costs R31 in South Africa, The Economist said, versus $US5.51 in the United States, meaning there is an implied exchange rate of 5.63. "The difference between this and the actual exchange rate, 13.36, suggests the South African rand is 57.9% undervalued," the index noted.

The publication described the dollar as "strong as a bull", saying almost every other currency in the index had weakened relatively over the past year. Just two, the Swiss franc and Swedish krona, appeared overvalued against it, at 18.8% and 5.5% respectively.

Currencies shift, burgers stand

"Since The Economist last updated the Big Mac Index (BMI) […] burger prices have remained constant in 19 of 44 countries. But every currency has shifted in value," the publication added.

The Argentine peso has been the biggest mover since January, it noted. Then, it appeared 25% undervalued compared with the dollar, versus 50% now. Factors influencing this shift included fears of a debt crisis and inflation.

Similar factors influenced two other emerging-market currencies, namely the Turkish lira and Brazilian real, two other big movers.

Norway's krone, by contrast, gained considerable purchasing power, with a 14% fall in the dollar price of a Norwegian Big Mac resulting in a shift from the krone appearing 18% undervalued in January to appearing 5% overvalued in July.

The British pound, meanwhile, has taken a knock since the Brexit vote in 2016, now appearing 23% undervalued.

Shortcomings

The system does, however, have its critics. According to Bianca Botes, Corporate Treasury Manager at Peregrine Treasury Solutions, the Big Mac Index "assists in making exchange rate theories more understandable" but "cannot be considered a precise measure of currency under- or over-valuations".

"My biggest concern lies with the non-internationally traded items, such as labour, that goes into the underlying good – in this case the Big Mac Burger," Botes told Fin24. Every country has its own unique set of economic fundamentals that drives the prices of these goods such as labour constraints and GDP per capita, and one cannot assume that these factors are similarly priced across countries."

The Economist says it has attempted to address potential shortcomings in more recent calculations.

"One beef with the BMI is that burgers cannot easily be traded across borders," The Economist acknowledges. "Neither can some inputs to production, such as land and labour." To allow for this, another version of the index adjusts Big Mac prices for GDP per person.

But Botes says there are subtleties in individual economic backdrops that should be considered as well. "The relevance of the Big Mac Index has been argued over many years, but I believe that it has some value in terms of offering a high-level valuation of currencies," she says.

"However, it falls short when dealing with various economies, each with their own economic backdrop.

"The Big Mac Index is also practical in a single good environment, but this is not the reality markets operate in – we face multi-good economies, all in unique stages of economic growth and development, and an oversimplification in a complex environment will always leave room for error."

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the economist  |  rand  |  dollar  |  currencies
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