The rand at R6,70 per United States dollar remains more than 20% undervalued when using the Big Mac measure. If one compares prices relative to earnings or “quality of life”, the rand is 38,5% undervalued, according to South African commercial bank Absa.
Although Absa, in common with most other South African-based economists, expects the rand to weaken next year, Absa senior economist John Loos said that given the rand’s current undervaluation, the rand could be stable or stronger for longer.
“It would appear from both a purchasing power parity [PPP] and real exchange rate point of view that the rand is not overvalued or overly strong. The key question is whether industrialists adapt to a stronger rand or whether a deterioration in the balance of payments will force the rand sharply weaker,” Loos said.
Using the Big Mac measure of PPP it is estimated that R5,30 per dollar would equalise the cost of a Big Mac between the US and South Africa.
Using the Union Bank of Switzerland measure of living costs in major centres, an even stronger level of R4,12 per dollar would equalise living standards between Johannesburg and major American cities.
The rand also remains undervalued on a PPP basis despite its move from a record worst level of R13,86 per dollar on December 20 2001 to this year’s best level below R6,70 on November 14.
The PPP rate is determined by choosing a base date. Then, by using inflation differentials, a theoretical PPP rate is established some time later.
South African Reserve Bank practice, in common with international best practice, is to use producer inflation, rather than consumer inflation, as so much of the consumer price basket, such as home loans and haircuts, is not traded between countries, while goods in general are.
The key determinant of a “good” PPP rate is to choose a starting date that is not distorted by special events. So January 1980 is not a good starting point as that was when the gold price reached a record high.
In similar fashion, starting dates in 1984/1986 or 2000/2003 are not good starting points as the rand was extremely volatile in these years.
Relatively good starting points are January 1990, the month before the African National Congress was unbanned; April 1994, the month that the ANC won power at the ballot box; and April 1995, the month after the commercial
and financial rands were unified.
Using these starting dates, the August 2003 PPP rates are R5,90 per dollar, R6,05 per dollar and R5,67 per dollar respectively.
The Reserve Bank does compile a PPP rate, which it calls the real effective exchange rate. This rate is a trade-weighted rand index, where the comparison is made with 13 currencies. The four most important currencies with their weights in brackets are the euro (36,38%), the US dollar (15,47%), the British pound (15,37%) and the Japanese yen (10,43%).
Due to data lags, the latest available real effective rate is for July 2003 when the rate was 86,93. As the base is 1995 at 100, the real effective exchange rate confirms that the rand is about 13% undervalued compared with its
1995 level.
At the time of the February 26 2003 Budget, when exporters started complaining about the strength of the rand, Finance Minister Trevor Manuel said the rand was still undervalued. At that stage the rand was trading at R8,15
per dollar.
Since then Reserve Bank Governor Tito Mboweni has repeatedly affirmed that the rand remains undervalued.
The August 14 monetary policy committee statement said: “The level of the real effective exchange rate of the rand was still below the index values in early 2000, leaving domestic producers in a more competitive situation in
export markets than at the turn of the century.”
In December 2001, the rand reached a record worst level of R13,86 per dollar, R20,0866 rand per pound and R12,4790 per euro. It finished 2002 at R8,59 per dollar, as the rand was the best performing currency against the dollar in 2002.
The rand averaged R8 per dollar in the first half of the year after briefly moving above R9 per dollar in January, and has so far averaged below R7,25 per dollar in the second half. — I-Net Bridge