How much the rand is really worth

The rand continues to be one of the world’s most undervalued currencies, the latest update to The Economist’s Big Mac index has shown.

The Big Mac index is a currency comparison tool that uses the local prices of McDonald’s Big Mac burgers in different countries to calculate the “real” exchange rate between these countries’ currencies and the US dollar, British pound, euro, Japanese yen, and Chinese yuan should be.

It is based on the theory of purchasing-power-parity (PPP) — the notion 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 any two countries.

Although The Economist originally invented the Big Mac Index as a light-hearted guide to whether currencies were at their “correct” level, it has become a global standard used in several economic textbooks and academic studies.

The graphic below explains how the Big Mac Index determines the implied exchange rate and the extent to which a currency is overvalued or undervalued.

According to The Economist, a Big Mac currently costs R33.50 in South Africa and \$5.65 in the US.

The implied exchange rate is calculated by dividing the South African price by the US price, which works out to around R5.93.

The difference between this value and the actual exchange rate of R14.66 suggests that the rand is 59.6% undervalued.

This makes it the world’s third-most undervalued currency, with only the Russian rouble and Lebanon pound being more undervalued.

The graph below shows the overvaluation or undervaluation of several currencies against the US dollar.

While PPP indicates where the rand should be heading in the long run, it does not address the country’s current equilibrium rate, The Economist states.

For a more accurate reflection of the real value of the rand, the publication also takes the Growth Domestic Product (GDP) per person of the countries into account.

This addresses the criticism that you would expect average burger prices to be cheaper in developing countries than in rich ones because labour costs were lower.

The graphic below illustrates how this revised calculation works.

When you convert the South African price of the Big Mac to the US dollar, it works out to \$2.28, which is 59.6% less than the US price.

Based on differences in GDP per person, a Big Mac should only cost 42.5% less, or \$3.25, with cheaper labour costs accounted for.

With its actual price at \$2.28, it is still 29.6% undervalued.

Factoring GDP per capita into the equation, the rand is the world’s seventh most undervalued currency.

If you wish to view what the “real” value of other currencies should be, The Economist provides an interactive version of the Big Mac Index.