Category Investments

Adjusted Big Mac Index reveals Rand as one of the most undervalued currency

11 August 2014 Mohammed Nalla, Nedbank

The recently launched Adjusted Big Mac Index* shows that the South African Rand is currently one of the most undervalued currencies in the world. The Adjusted Index – which addresses the criticism of the original Big Mac Index assumes that the average burger prices to be cheaper in emerging countries than in developed ones because labour costs are lower – shows the Rand is undervalued by 23.6% against the Dollar.

While this is significantly better than the Rand’s current 53% undervaluation reflected in the original Big Mac Index, it still places the currency as the fifth most undervalued currency against the Dollar and the Euro after Hong Kong, India, Japan and Malaysia.

According to Mohammed Nalla, Head of Strategic Research at Nedbank Capital, while there are certain key technical flaws which constrain the usefulness of both the original and adjusted Big Mac Indexes as an accurate gauge of relative over or under valuation of currencies**, he agrees that the Rand is undervalued although the quantum is debatable.

“In South Africa, the litany of factors contributing to our undervaluation includes labour unrest, a large output gap in our economy, massive structural deficiencies in our education and healthcare sectors, labour market rigidity, the threat of land reform and many others.

“As a result, the Rand has deteriorated and continues to remain weaker than its long run average. A persistently weaker currency unfortunately erodes the real purchasing power of the South African consumer in global terms and as we remain a large net importer, this is, in my view, a negative for the economy as a whole. This is due to South Africa not being positioned as a net exporter and as such, calls for a weaker Rand (historically) to spur growth have always been flawed.”

Nalla adds that much negativity is currently being priced into the Rand. “Any further deterioration in domestic macroeconomic fundamentals or the social and labour unrest will likely continue to taint the outlook for the local unit. That being said, provided that no further slippage occurs, it is likely to remain rather range-bound and take direction from global developments. As the rand remains a largely liquid emerging market currency, global sentiment toward emerging markets is also a large determining factor.”

He says that the best outcome for business is not a ‘strong’ or a ‘weak’ Rand but rather a stable exchange rate. “Volatility erodes confidence and constrains business activity and investment in the medium to longer term. Also, with history as a guide, the Rand strengthens slowly but tends to weaken quickly and violently. As such, the risks are always disproportionately skewed towards the Rand with further weakness regardless of an absolute level.

“In light of this, a proactive strategy to hedging Rand risks is critical. Businesses need to do their sums and work out at what levels they can profitably operate. Then, around these levels, they should look to a variety of hedging strategies to optimise their outcome.”

Nalla advises that sophisticated businesses would do well to look at the asymmetric hedging opportunities which derivatives or currency options provide. “The best way to do this will be in discussion with experts in this field who can assist in putting a diversified hedging strategy in place that suits their unique requirements.”

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