Emerging Market Currencies and the Big Mac

 

The Economist’s Big Mac Index ( Link  ) looks at the dollar cost of a hamburger sold by McDonald’s restaurants in some 60 countries. The index shows a remarkable range of prices around the world. In the latest survey, the most expensive burger was found in Switzerland ($6.54) and the cheapest in Russia ($2.04).  Presumably, these hamburgers are identical, with the same combination of bread, beef patty, lettuce and sauce. The price in each country should reflect the cost of the materials, labor and rent, profit margins and taxes. The index pretends to shed some light on the relative costs of doing business in different countries, and, given that it has been measured for some 30 years, it can also provide an indication of the evolution of business costs. Moreover, it can be used as a proxy to measure the relative competitiveness of currencies around the world.

The Big Mac data confirms the strength of the USD following a 8-year period of USD appreciation against both developed and emerging market currencies. EM currencies are inexpensive compared to the high levels of 2007-2011 and generally in line with long-term historical levels. Competitive currencies, low earnings multiples and higher GDP growth compared to the United States are the foundation for a positive outlook for EM stocks.

 

 

In terms of specific emerging market countries, the relative strength of the Brazilian real is noteworthy. The BRL is the most expensive EM Big Mac currency, which is curious given the depressed economy, current account deficit,  low savings and low interest rates.

The data is detailed below for the primary EM countries of interest to investors.

It is important to view the data in a country-specific historical context to understand what the data means. We look below at several specific cases, and compare the data for the Big Mac Index with the Real Broad Effective Exchange Rate (RBEE) as measured by the Bank for International Settlements (BIS)

Brazil

The first thing to note is that the current relatively high valuation of the Brazilian real is not an anomaly. Except for a brief period in 2015, one has to go back to 2000-2004 to find a “cheap” real. The current “weakness” of the BRL appears largely explained by the strength of the dollar, which has appreciated against almost all currencies over the past eight years. The data is confirmed by the BIS RBEE data which shows the BRL to be about in line with its 25-year average. The BRL probably has some moderate potential for appreciation when the economy experiences a more robust economic recovery and will quickly find itself in overvalued territory, and impediment to trade and investment. The strong BRL is very difficult to reconcile with the Bolsonaro’s market-opening initiatives, such as the recent trade agreement with Europe.

Thailand, Chile, South Korea, and Colombia

The Thai Baht has been on a path of appreciation, driven mainly by capital inflows. This is reflected both in the Big Mac and RBEE data, and should be a major headwind for a country that relies on exports in an increasingly competitive market and in a region where most countries have kept their currencies very competitive. Chile, South Korea and Colombia all have currencies that are strong relative to other EM currencies but more-or-less neutrally positioned relative to their own histories.

Peru

The data on the Peruvian sol is confusing. The Big Mac Index shows a currency that has weakened well below its peak and appears to be at a competitive level. However, RBEE numbers point to significant overvaluation, near peak levels.

China

The Chinese yuan is on a long-term gradual appreciation path, in line with the growth and increased sophistication of economic output. This is confirmed by both the Big Mac and RBEE data. The recent dip in the yuan is a response to trade war tensions. Despite a burgeoning current account deficit and capital flight, Beijing appears committed to a stable yuan to further its gradual internationalization of the currency.

 

Turkey and Argentina

By any measure, the Turkish Lira is very undervalued.  The Big Mac Index shows Turkey at record-lows both relative to its history and compared to other countries. This confirms by the RBEE which shows Turkey starting to rebound from near record-low levels. For an investor in Turkish assets, the very cheap lira should provide a strong boost to total dollar returns when the economy recovers over 2020-2022.

The same goes for Argentina. The peso is cheap by any measure and should provide support for asset prices if politics do not get in the way. Argentina is much better positioned to benefit from free-trade deals than Brazil.

Russia

Russia provides an interesting contrast to Turkey. Though the Russia Big Mac is very cheap, it is only marginally cheaper than it has been for the past 20 years both relative to the USD and to other countries. The BIS RBEE shows that the ruble is only cheap relative to the peak of the 2008-2012 commodity boom but in line relative to history. This points to moderate upside for the ruble, unless, of course, oil prices rally strongly.

South Africa

In the same vein as Argentina, the rand is inexpensive by any measure and should provide support for asset prices, if politics and capital flight do not get in the way.

Malaysia and Taiwan

Both Malaysia and Taiwan are committed to maintaining their currencies at very competitive level, to support exports in an increasingly hostile world for small export-oriented countries.

Indonesia and the Philippines

Unlike Taiwan and Malaysia, Indonesia and the Philippines have allowed their currencies to appreciate, driven by capital inflows, though from a Big Mac basis they are in line with history.

India

The rupee is on an a gradual appreciation trend. The rupee is likely to trade increasingly in line with oil prices as the country has become the biggest importer of oil in the world. Currency strength is not likely to be a boost to investor performance from current levels, unless oil prices collapse.

Mexico

The Mexican peso is very cheap, but on a downward trend. AMLO’s policies are driving both foreign and domestic capital out of Mexico while Trump unsettles investors with trade tensions.

Trade Wars

  • Balkanizing technology will backfire on the U.S. (FT)
  • A G-2 world (project syndicate)
  • Ian Bremmer (Aviva)
  • Post-dollar networks (project syndicate)
  • Investing in the age of deglobalization  (FT)
  • Is American diplomacy with China dead? (AFSA)

India Watch

  • India’s digital transformation (McKinsey)

China Watch:

China Technology

Brazil Watch

 

EM Investor Watch

Tech Watch

  • Investing in Asian Innovation (Oppenheimer)
  • Trends in battery prices (BNEF)
  • Mary Meeker’s Internet Trends report (techcrunch)
  • Germany is losing the battery war (Spiegel)
  • Does automation in Michigan kill jobs in Mexico? (World Bank)

Investing