Rand Looks Cheap Again on the Big Mac Index

The latest Big Mac Index suggests the South African rand is materially undervalued against the United States (US) dollar, at least on a simple purchasing power parity test built around a burger.

The Big Mac Index is released annually by The Economist and looks at what a Big Mac – the signature burger of the fast-food chain McDonald’s – costs around the world.

The Economist first ran the index in 1986 as a light-hearted way of comparing currencies. The newspaper says: “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 this case, a burger) in any two countries.”

According to latest prices, a Big Mac costs about R54.90 in South Africa and $6.12 in the United States. That implies a purchasing power parity exchange rate of roughly R8.97 to $1. Set against the market exchange rate used in the study, around R16.35 to $1, the rand comes out about 45.1% undervalued on the index.

The index shows the gap between what South Africans pay in local currency for a globally recognisable good, and what Americans pay in dollars. That gap can reflect many things beyond mispricing, including South Africa’s country risk premium, weaker growth expectations, and periodic capital flight.

Even so, the headline result is hard to ignore. A reading that points to an exchange rate closer to R9 to $1 is a reminder that the rand often trades less like a pure reflection of domestic prices, and more like a barometer of global risk appetite and South Africa’s political and fiscal credibility.

That helps explain why the rand can remain cheap on a burger-based measure even when it rallies in the market. It is also why the index is most useful as a long-run signpost, not a short-run trading signal.

Here at The Common Sense our economics and policy editor, Bheki Mahlobo, last year predicted that the rand could trade well under R16 for a dollar, which came to pass earlier this year, driven by a mixture of factors, primarily global.

He has argued that the rand could even strengthen to threaten R15.20 for a dollar if global and local conditions remain favourable.