We live in an extremely complex and competitive global economic environment. Things are getting a lot more complicated in the aftermath of the global financial crisis as countries are still struggling to restore output—some through pushing exports by deliberately undervaluing their currencies. In such an environment, can a burger from a global fast food joint tell you by how much a currency is overvalued or undervalued? The Big Mac index, created by T he Economist newspaper in 1986, attempts to do just that.
What is it?
The big Mac index, as The Economist puts it in its 2 February edition, is a “light-hearted analysis of foreign-exchange rates”. The Big Mac index only has one item—the Big Mac sold by the McDonald’s in a number of countries.
The India index: Since Big Mac is not sold in India because it contains beef, the index takes Maharaja Mac into consideration which contains chicken.
How does it work?
The theory behind the index is purchasing power parity (PPP), which basically says that prices and exchange rates adjust in a way that over time similar goods should cost the same in different countries. The index compares the price of Big Mac in the US with other countries to see if they are undervalued or overvalued compared with the US dollar. For example, in the last issue (2 February), the burger costs $4.37 in the US, while the Canadian version costs $5.39, indicating that Canadian dollar, compared with the US dollar, is overvalued by 24%.
Further, according to the index, the currencies of Norway, Switzerland and Brazil are overvalued compared with the US dollar, while currencies of emerging markets such as India, Russia and China are undervalued. Although the Index is a popular reading, critics have pointed out that since means of production, including the labour cost, is lower in poor countries, the cost for McDonald’s is also lower and may not necessarily indicate undervaluation.
The case of the indian rupee
Interestingly, according to the index, the Indian rupee is undervalued by about 60%, but if it was fairly valued in line with the index, things would have been far more complicated in India. A stronger currency in India will possibly worsen the external financial situation. India is running a large current account deficit, which is widely expected to have crossed 6% of the gross domestic product in the third quarter of the current fiscal. Therefore, instead of the rupee being undervalued, experts argue that with consistently high inflation compared with the developed world, rupee is overvalued. A weaker rupee, theoretically, will push exports and curb imports and allow adjustments on the current account.