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Blog: 2 August 2017 (Big Mac Index and what it says about the value of the South African Rand)
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In today's blog we take a look at the well known Big Mac Index and what it says about the value of the South African Rand, and what it's implied value for the Rand is based on purchasing power parity (PPP). According to this well known index the Rand is grossly undervalued and this has been the case for as long as data has been available for the Big Mac Index.
So what is the price of a Big Mac in US Dollars in South Africa vs the price of the same Big Mac in US Dollars in the USA? Read below to find out more about the Big Mac Index and what it says about our exchange rate. For more details on the Big Mac index and more country details, see The Economist: Big Mac Index |
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Big Mac Index
The chart below shows the dollar price of a Big Mac in both the USA and South Africa over time. And it is pretty clear that Big Mac's are a lot more expensive in the USA than in SA where you get way more "bang for your buck".
So from the graphic above it is clear to see that the Dollar Price of a Big Mac in South Africa is a lot less than the Dollar Price of a Big Mac in the United States. In July 2017, while a Big Mac cost around $2.26 in South Africa, that same Big Mac sold on average for $5.30 in the United States. Thus a rough estimate of currency under/over valuation based on the price of a Big Mac in both countries and calculating the purchasing power of each currency, the South African Rand is under valued by a massive 57.34% and the implied Rate at which the Rand should be trading against the dollar is R5.66/$1 and not where it is currently sitting at around R13.27 to the US dollar. The line chart below shows the implied Rand/Dollar exchange rate over time using the PPP as derived from the Big Mac Index.
What is clear how much more volatile the actual exchange rate is compared to the implied exchange rate thats based on the prices of Big Mac's in both South Africa and the USA. Prices are clearly far more stable than the exchange rate. Part of the reason for this is the fact that the exchange rate is driven by a whole host of factors that might not necessarily affect prices of burgers for example. Think credit ratings and "junk status", market sentiment, currency speculation, currency manipulation (which we know happened based on findings from the competition commission, foreign direct investments and balance of payment flows etc.
In the long run currencies should move until PPP reaches equilibrium, but the fact that South Africa's currency has been a lot weaker than the implied exchange rate clearly shows that there are significant issues in South Africa's economy and that there is clear lack of confidence in the local currency and market participants clearly do not think that the currency deserves to be trading close to it's implied exchange rate based on the Big Mac Index.
For a more detailed history into the South African Rand/US Dollar Exchange Rate, see our Rand Dollar Exchange Rate
In the long run currencies should move until PPP reaches equilibrium, but the fact that South Africa's currency has been a lot weaker than the implied exchange rate clearly shows that there are significant issues in South Africa's economy and that there is clear lack of confidence in the local currency and market participants clearly do not think that the currency deserves to be trading close to it's implied exchange rate based on the Big Mac Index.
For a more detailed history into the South African Rand/US Dollar Exchange Rate, see our Rand Dollar Exchange Rate