Thursday, December 31, 2009

‘Big Mac’ test shows rand is really not too strong

hat tip: Black Coffee

‘Big Mac’ test shows rand is really not too strong

Published: 2009/12/30 07:06:03 AM

THE rand is more than 30% undervalued against the dollar based on The Economist magazine’s Big Mac index calculation of actual purchasing power, says SA’s Free Market Foundation.

This flies in the face of concern that the rand’s recent strength — it was one of the best- performing currencies this year — may undermine SA’s economic recovery by reducing the competitiveness of local exports. Its rise of more than 27% versus the dollar since January prompted calls from trade unions, business organisations and top government officials for steps to weaken the unit.
Both the Treasury and the Reserve Bank have voiced concerns about the effect of rand strength on the economy.This has been viewed as a form of verbal intervention aimed at weakening the currency. But according to the Big Mac index, devised almost 25 years ago to measure the real buying power of currencies, rather than exchange rates, the rand is 32% undervalued against the greenback.

Jason Urbach, an economist at the Free Market Foundation, calculated the rand’s Big Mac purchasing power parity (PPP) last week, based on an exchange rate of R7,39/. The unit was trading at R7,41/ late yesterday.

Urbach’s assessment backs the view that the currency could strengthen further in the first half of next year. Citigroup sub-Saharan Africa strategist Leon Myburgh expects to see the rand rallying to R6,75/ or R6,50/ in the second quarter of the coming year, due partly to the 2010 Soccer World Cup.Myburgh predicts that the event, which takes place in June and July, will attract 400000 overseas tourists, who will spend 1bn-2bn in SA.

“I wouldn’t be surprised to see in the first half of the year the overall theme being rand strength rather than weakness,” he told Business Day. In the second half of the year, he sees the rand weakening to R8,25/.Brait economist Colen Garrow has created a PPP index based on producer inflation, and this index also suggests that the rand is undervalued.

“It says the rand should be at R6,82/,” he said yesterday. Despite domestic factors, which could keep the rand weak, external forces such as rising commodity prices would drive the rand in the first half of next year, he said.
That could take the rand to its PPP level, but later in the year it was likely to weaken to R8,25 to the dollar.

The Big Mac index uses the price of one standardised product, a McDonald’s burger available in more than 100 countries, to measure real buying power. This strips out the distortion of market exchange rates.

Myburgh regards the index as an international reference point but cautions that it is limited because it does not look at a large number of products.

Urbach says most other developing countries’ currencies are also undervalued against the dollar based on the Big Mac index, ranging from China and Ukraine, which were both 49% undervalued.

Norway’s currency is 72% overvalued.

It is also possible to calculate how long it takes workers in various cities around the world to earn a Big Mac, based on average earnings. A recent report by UBS called Prices and Earnings showed it would take about 12 minutes to earn a Big Mac in Chicago, compared with 26 minutes in Johannesburg and more than two hours in Nairobi. The global average was 37 minutes.
Urbach says the contribution to global gross domestic product from developing countries is significantly underrated based on market exchange rates.

China ranks as the sixth-largest economy in the world based on market exchange rates, but using PPP rates makes it the second- largest, ahead of Germany, the UK and France.
SA has moved from 33rd to 21st place, ahead of Switzerland and Sweden, on this basis.

4 Opinion(s):

Dachshund said...
This comment has been removed by the author.
Anonymous said...

Did Julius do that math?

You spent 10 billion on stadiums then people come and spend 2 billion during that month.

Fuck where are the math gurus?

Dachshund said...

Expect interest rates to rise next year in line with inflation.

Anonymous said...

Inflation? Shit the last country to worry about tomorrow was Zimbabwe. Getting them to think further than lunchtime is hard enough.