Big Mac prices suggest rand is still too low

The Big Mac Index started as something of a joke, but 40 years later it continues to demonstrate the relative value of currencies in a practical way that everyone can understand.

The Economist says it created the Big Mac Index in 1986 as a light-hearted guide to whether currencies are at their ‘correct’ level.

“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 any two countries,” it says.

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Big Mac Index: Is the rand undervalued?

The index uses the McDonald’s Big Mac burger as a proxy for a basket of identical goods to compare the exchange rate of 59 countries.

In Ronald McDonald’s world, the rand should trade at well below R10 to the dollar. A Big Mac costs $6.22 in the US and R56.90 in South Africa.

On the assumption that the burgers are identical and should be priced the same, the exchange rate should be R9.14 to the dollar to result in parity. However, the rand is trading at R16.24, despite strengthening in recent weeks from above R17 at the end of March 2026.

Adrian Saville, chair of economics, finance and strategy at the Gordon Institute of Business Science, says actual exchange rates systematically deviate from this equilibrium.

“This leaves currencies like the Swiss franc perpetually overvalued and emerging market currencies structurally undervalued.

“When The Economist published its first Big Mac Index 40 years ago, it turned an informal benchmark into a window on a persistent economic puzzle: why currencies remain chronically detached from their theoretical fair value?

“Under standard purchasing power parity theory, an identical product should cost the same across open borders once converted into a common currency.”

Saville says the gap exists because foreign exchange markets do not price goods alone.

“First, a currency’s domestic purchasing power is heavily anchored by non-tradable inputs. Over three-quarters of a burger’s final price is driven by local rents, energy costs and labour.

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“In high-productivity economies, generous wages across export sectors bid up local costs across the rest of the domestic economy, making services expensive. In developing markets, lower average labour costs and local real estate keep prices low.

“Second, what keeps the gap anchored over decades is market friction and risk pricing. Exchange rates trade on global capital flows, interest rate differentials and sovereign risk.

“When a currency trades at a 30% or 40% discount to its theoretical parity, the foreign exchange market is not making a mathematical error. It is charging a live, structural risk premium for policy uncertainty, fiscal drag and domestic growth ceilings,” he says, warning that relying on theoretical valuation to bet on currency appreciation is a dangerous path.

“A currency can remain fundamentally undercooked for decades if the underlying institutional drivers fail to shift.”

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Saville says there are three primary drivers of SA’s exchange rate.

The first two – commodity prices and international investors’ sentiment towards emerging markets – are largely outside our control.

The third is the local economy, the state of which can be influenced through politics and policy.

Two out of three

Unfortunately, only two of the three drivers that could lead to a stronger rand are currently in positive territory.

Commodity prices are high and investment sentiment towards emerging markets is ‘risk on’. Saville points out that the rand is often a proxy for risk appetite towards emerging markets, as it is a popular and highly liquid emerging-market currency among international investors.

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“Local factors are a drag,” he says, describing economic growth as “dismal” at less than 1% and well below population growth.

“Our per capita income has been falling for 15 years.

“The SA economy is in better shape than it was 18 months or five years ago, but economic fundamentals need to improve further for the rand to strengthen.

“Any improvement in the economy and structural improvements to support growth are already factored into the rand, which has strengthened over the last year or so,” says Saville, “but the rand is still undervalued In terms of purchasing power parity.”

However, he says he is not predicting an improvement, rather making an observation.

Strong performance

Ricardo Smith, chief investment officer at Absa Investments, says the rand has improved significantly.

“We have seen a strong performance from the rand over the past 12 months, strengthening against the US dollar by about 20%.

“Looking ahead, the outlook can be divided into three periods. In the short term, the rand remains excessively volatile, being among the most liquidly traded emerging-market currencies globally and often used as a proxy for risk,” he says.

“Over the medium term, notwithstanding a slightly overvalued rand from an interest-rate differential perspective, a relative purchasing-power-parity perspective, a current-account perspective, elevated geopolitical tensions and local political uncertainty, the rand could continue to prove resilient.

“This resilience stems from fiscal consolidation, government debt containment, potential further credit-rating upgrades, increased allocation to economic development, a lower inflation target, strong monetary policy and continued demand for gold and platinum.”

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However, Smith warns that the long-term view is different.

“Despite these positive factors, we expect the rand to moderately depreciate against the dollar, broadly in line with the interest-rate differentials.”

Taking a long-term view, he therefore believes the rand is currently too strong and will continue to weaken because of the “structural differences between the two economies”.

Elections

Short-term factors could lead to further volatility, including the upcoming local elections in November.

Mamokete Lijane, global markets strategist at Standard Bank CIB, says local elections are unlikely to have a significant impact on the rand.

“My view is that local elections are unlikely to have much of an effect on the rand. However, there is a chance that we see some movement, but only insofar as they are read to signal something about governance at the national level.

“For example, if the contest at the local level is so intense as to threaten the stability of the government of national unity [GNU], the rand would respond negatively. A weak showing by the parties in the GNU could be seen as a signal of what will happen at national elections, suggesting another ruling coalition would emerge.

“Again, this would be negative for the rand, but only as we got closer to national elections.

“Another potential flashpoint for the currency – and I would put the likelihood of this as very low – would be if the elections were destabilised in any way,” says Lijane.

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