The rand is one of the undervalued currencies in the world, according to The Economist. Currently, it ranks at the top of the list together with the Russian ruble and the Lebanese pound. In today’s article we will reveal why is the South African Rand so undervalued despite the fact that it’s according to South African Forex brokers one of the most traded currencies in the world.
In this in-depth guide you’ll learn:
- The Big Mac Burger Index
- Cause of Currency Undervaluation
- The Rand is Not The Worst
- Signs Of Growth
And lots more…
Let’s dive right in…
The Big Mac Burger Index
👉 First things first. Let’s understand how to calculate currency valuation. To determine if a currency is undervalued or overvalued, you need an index that compares it to another currency (typically the United States Dollar). The Economist uses the big mac burger index to determine the true value of the currency. The reason behind using the fast-food meal is due to its worldwide popularity and fairly consistent price.
👉 While the Economist appreciates that burgernomics cannot measure monetary misalignment, the index makes it easy to understand the exchange rate theory. In fact, the theory has been adopted by many scholars and included in economic textbooks and about 200 academic studies.
👉 The Big Mac index is based on purchasing power parity (PPP) theory. The theory stipulates that the exchange rates of two currencies are at equilibrium if the currencies can buy the same basket of goods and services in the two countries in the long run.
👉 The Big Mac index uses two methods to measure the real value of the currency. The first method is a PPP measure that uses gross prices. The other method is the adjusted index that factors in the local GDP data.
👉 The Big Mac burger costs R33.50 In South Africa and $5.66 in the United States. This means that the exchange rate should be € 5.42 per dollar. However, the exchange rate at the time of the report was 15.52 per dollar. This means that the South African rand is undervalued by 61.9%.
The missing Picture
👉 There is a downside to using the raw index in measuring currency valuation. The argument is that producing burgers in wealthier economies is more expensive due to purchasing power parity. Therefore, the Economist factors in the GDP per capita to enhance price valuation.
👉 The rand is still undervalued even using the adjusted index. However, unlike the direct conversion data, the rand ranks sixth in the world instead of the most undervalued currency.
👉 To give you a clear picture, the big mac costs $5.66 in the United States and $2.16 in South Africa. Using the direct data, the rand is undervalued by 62%. However, when you factor in the GDP per capita, the big mac should cost about $3.17 (44% less). Therefore the rand should exchange R10.47 for a dollar. This represents a 32.5% undervaluation using the GDP-adjusted big mac index.
Cause of Currency Undervaluation
👉 A currency is considered undervalued if it has a lower value when converted to a foreign currency due to existing economic conditions. Moreover, lack of demand even when the economy is doing well could also cause undervaluation. Other Factors that affect the valuation include investor risk appetite and local and global factors that affect the market stability.
👉 For instance, the South African economy is experiencing a recession due to political issues. The economy is therefore not suitable for foreign investment. Load shedding and other infrastructure failures have derailed development. The Covid 19 pandemic, UK Brexit, and US elections have significantly affected the global markets making things even worse.
The Rand is Not The Worst
👉 While South Africa has been the most undervalued currency for quite some time, it is not the most undervalued. According to the big mac index, the rand trading at R8.28 was undervalued 39% a decade ago. Currently, the Lebanese pounds tops the list at 68.7% undervaluation. Lebanese is followed by Russian Ruble and Turkish Lira at 68% and 64.5% undervaluation, respectively.
This means that the three countries have the cheapest Big Macs. As per Statista, Only the Swiss Franc (+28.8%), Swedish Krona (+12.65%), and Norway Krona (+7.5) are overvalued against the dollar.
👉 In addition, Global factors have significantly affected the rand movement in the recent past. Also, Mining and retail sales from late 2020 are not good for the currency. Moreover, the rising government debt exacerbated by the covid 19 pandemic limits the potential of rand appreciation.
Signs Of Growth
👉 South Africa is the biggest gold producer. Fortunately, strengthening gold prices and South Africa’s positive net exports could boost rand demand and ultimately boost its value. While the report shows that the rand was the most overvalued currency in mid-2020, it has experienced a positive growth in2021. The growing global optimism regarding coronavirus and the conclusion of US presidential elections have given the rand a good footing.
👉 According to Nedbank, the currency is approaching a fair value. Low-interest rates in advanced countries and global forces will contribute to the rand appreciation. The banks added that the currency would appreciate if the global risk appetite increases. The Rand is expected to appreciate in the short to medium term.
👉 Currently, the rand is not the most undervalued currency. Undervalued by 68%, The Russian ruble has overtaken the rand. While one dollar is exchanging at 74 rebels, the dollar should be cost 28.85 according to the Big Mac index. Conclusively, Lebanon, Russia, and Turkey currencies are more undervalued than the rand.