Big Mac index finds rand undervalued
SOUTH Africans hoping for a stronger rand can draw hope from pure economic theory uncorrupted by economic and political realities.
The Economist's Big Mac index suggests the rand is 38% undervalued against the US dollar. The index is based upon the theory of purchasing-power parity (PPP) which has as its basis the assumption that the same basket of goods should cost the same whether in Pretoria, Paris or Pennsylvania.
The basket used is a McDonald's Big Mac. A Big Mac costs $2.56 in the US and R8 in SA - this suggests that in the real world, $1 should get you R3.13; instead using the current exchange rate of R5.04, an SA burger only costs $1.56 - 38% below the value suggested using the PPP method.
After the Asian crisis, the cheapest burgers can be found in Malaysia where they cost $1.16 - with Switzerland proving the most expensive at $3.87.
Over the past few years the Big Mac index has proved fairly accurate in suggesting exchange rate trends; so the US dollar has strengthened considerably against currencies such as the Deutschmark which previously was considerably overvalued.
Clearly the Big Mac index is not a very reliable indicator - especially in emerging economies where so many other non-economic factors play a role. In SA, investor scepticism about political stability is a discount inherent in the currency. The burger itself is subject to a number of cost inputs that differ from country to country.
Yet by and large there is light at the end of the tunnel that suggests the rand will eventually turn the corner. ý Producer price inflation recorded its weakest rise in nearly 28 years last month, the CSS said this week.
The year-on-year increase in the PPI slowed to 2.3% in March from February's 2.5% - the lowest since March 1970. The data was better than economists' consensus forecasts for a 2.5% rise.
The cost of locally produced goods was up by 3.3%, while imported producer costs actually cost 1.9% less than in March 1997.