The price of Big Macs around the world Photo Twitter/@nortonsig\
South Africa – The rand has become a topic of concern due to its perceived undervaluation in comparison to other major currencies. The Economist has updated its Big Mac Index and according to the calculations, the rand is more undervalued against the dollar than at the start of the year.
The Big Mac Index takes the price of a Big Mac burger in different countries and compares it to its price in the United States. The underlying assumption is that the same product should cost roughly the same across countries, and any significant difference could indicate currency undervaluation or overvaluation, explained Dr Dale McKinley, economist. The results indicate that the exchange rate should be R8.94 and not R18.91.
“In this case the Big Mac was 55% undervalued in the sense of what a Big Mac costs here [in South Africa] which is around R50 whereas in the United States a Big Mac cost about just under $6. They extrapolated that and said that actually a Big Mac here should cost quite a bit less in the context of the rands than that and therefore the 50% is the under valuation in this case.”
While some take this index as law, McKinley, personally, does not find this test accurate. Believing it to be nothing more than a “PR gimmick”.
“It doesn’t really measure the reality of the economy. It makes for good headlines and makes for good conversation. It doesn’t really measure because it doesn’t consider all the other external factors that weigh on the valuation of a currency … I would argue that the rand is probably a bit undervalued but not nearly as much as the Big Mac Index would indicate.
Factors influencing the rand’s valuation
Several complex factors contribute to the undervaluation of rand. These factors encompass both internal and external dynamics that impact the currency’s worth. One being the interest rates. Countries in the West and Europe have begun hiking up their interest rates which has now made them a more appealing option for investors.
“We have a situation where over the last many years South Africa’s interest rates have been hiked quite substantially. For any investor, that’s a boon. If you have money to invest and you are seeking a country with a high interest rate, South Africa is a good place to invest because we’ve had high interest rates for a number of years. Whereas in the United States, the United Kingdom, North America, the rates have been very low up until very recently but what’s happened over the last two years is that banks in the United States and Europe have hiked rates. That makes them more attractive to investors. So what we have is money shifting from economies like South Africa, where investors and pension funds and so forth then take their money out of South African stock markets and Investments and put them in others. Now that would affect the valuation of a currency.”
Another factor is politics. With South Africa strengthening its ties to Russia, it goes against what the West and Europe are doing. South Africa could be punished for this in the form of investors not wanting to invest or take their money out of the country as they “are not playing ball”.
There are also the domestic social economic issues. The country has suffered from all sorts of issues, such as loadshedding and the July Riots, which has put our economy in “intensive care”. Add to it corruption and high crime rates, it is plausible many see the country as unstable and not worth a long-term investment, said McKinley.
“They might do short-term buying and selling and this then makes things more volatile because you have huge amounts of money coming in and out of the economy over very short periods of time as opposed to sustained investment. That obviously creates uncertainty and that creates a devaluation in the currency.”
SMread: ‘Not pro-Russia or anti-West’, says Pandor ahead of BRICS Summit
The impact of elections
With elections on the horizon, political uncertainty adds another layer of complexity to the currency valuation equation. The outcome of the elections, including potential coalition politics and policy changes, could impact investor sentiment and the currency’s performance. Stability and predictability in political and economic policies can contribute to a more favourable currency valuation.
“In the context of South Africa, what would be a positive thing in terms of valuation of our currency would be if we don’t have any further violence. If the political conflict sort of stabilises and where you have a political party that emerges that you can predict what kind of politics and what kind of policies are going to come. Unfortunately, looking at the next election, none of those things apply in South Africa. If we look at our situation conflictingly, we are having increasing amounts of conflict in our society. Politicians are becoming quite opportunistic and being populist and sort of hitting all sorts of buttons that create more division within society.”
As time goes by, it seems the ANC will no longer be the dominant force and rather, a coalition will take place. With coalitions, there is much uncertainty of how things will take place and what policies will be followed which only hampers investors confidence in South Africa, said McKinley.
The undervaluation of the rand is a multifaceted issue influenced by a combination of domestic and international factors. While tools like the Big Mac Index offer a simplified perspective on currency valuation, the reality is much more intricate. Economic stability, political certainty, trade relationships, and commodity prices all play a role in determining the rand’s value. The future of the rand’s valuation remains interconnected with a multitude of variables that shape the broader economic landscape.
Dr Dale McKinley spoke to Julie Alli on the issues of investing in gold, property and the likelihood of a BRICS currency and what it could mean for South Africa. Listen to that discussion here:
