Big Mac Index points to undervalued Rand – should be trading R5.20/$

By Lameez Omarjee

Johannesburg – The rand should be trading at R5.20 to the dollar, according to the latest Big Mac Index by The Economist.

According to the index, the rand is undervalued by 62.70%.

South African bank notes featuring images of former South African President Nelson Mandela (R) are displayed next to the American dollar notes. REUTERS/Siphiwe Sibeko

The Big Mac Index was put together by The Economist as far back as 1986. It measures whether currencies are at the “correct” level, based on the theory of purchasing power parity (PPP).

PPP suggests 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.

However, the index is not meant to be taken seriously as there are a number of limitations to its methodology.

“Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible,” said The Economist.

The price of a Big Mac in the US is $1.89, compared to R26.32 in South Africa. 

If the exchange rate were R5.20/$, a Big Mac should cost R9.83 in South Africa

According to the index, the rand should be trading at R6.78 to the euro, R8.52 to the pound sterling and R1.34 to the Chinese yuan.

Economist Dawie Roodt told Fin24 previously that the rand is undervalued. “It should be trading at a better level,” he said.

The factors dragging down the currency include high inflation, political uncertainty, weak economic growth and the increasing current account deficit.

Professor Jannie Rossouw, head of the Wits School of Economic and Business Sciences, told Fin24 by phone that R5.20/$ is “overoptimistic”.

Although the rand is undervalued, Rossouw said it is not undervalued by over 60%.

“I would say R12.50/$ would be more realistic,” he said. – Fin24

Source: http://www.fin24.com/Companies/TravelAndLeisure/rand-should-actually-trade-at-r520-big-mac-index-20170123

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