Has shilling finally outsmarted rand in the currency race?

I have been living in South Africa for 15 years and one frustration Kenyans based here face is the temperamental nature of the rand-shilling exchange rate.

A chart showing the historical rate for the past 10 years reveals that a single unit of the South African currency could be trading at Sh13.50 in one year and at Sh7.50 two years later. That is a significant 45 per cent swing within a short period of time.

Spare a thought for that person who negotiated an employment contract based on one’s salary in Nairobi prior to moving to Johannesburg.

Be equally empathetic to the parents whose children just joined a college in Pretoria and the move was planned based on the school fees quoted and living expenses estimate at their time of departure.

It is also a budgeting nightmare for the many who live here and have commitments in Kenya, like loved ones to support or a home to construct.
The rand was trading at Sh6.60 by last week.

This is an all time low occasioned by a strengthening US dollar, poor economic performance and a decline in exports.

The shilling, like almost all African currencies, has also been affected by the stronger dollar but the Central Bank of Kenya appears to have been more proactive in defending the local currency by implementing interest rate hikes.

The question is whether or not the current rand-shilling relationship is sustainable. Since mid-2011, the shilling has consistently gained against the rand from an exchange rate of Sh11 to its current level.

As the exchange rate is an important indicator of economic health, has the Kenyan economy outperformed South Africa’s to the extent that we should concede that the exchange rate would remain around Sh7 for the foreseeable future?

Factors that impact the exchange rate include differentials in inflation, interest rates, current account deficits, public debt, terms of trade, political stability and economic performance.

I could analyse each factor at length and phone a few economists for insight to come up with a conclusive answer for the rand. But as a layman, I much prefer the simpler alternative of looking up the price of a hamburger.

The Economist came up with the Big Mac index in 1986 as a light-hearted guide to whether currencies are trading at their “correct” level.

The index is named after McDonald’s best selling burger and is based on the theory of purchasing power parity, 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.

The index has since been incorporated into several economic textbooks and at least 20 academic studies. The essence of “Burgernomics” is that the Big Mac should cost about the same in Johannesburg as it does in London. If not, then the current pound-rand exchange rate is not at its correct level.

There are several limitations to Burgernomics including the fact that eating in international food chains like McDonald’s is not as popular in some countries as it is in others.

Local taxes also impact pricing and McDonald’s does not have the same pricing strategy for each country.

In addition, like all sandwiches, they rarely look and taste exactly the same in all countries, the most differing version being that of India which is made of chicken given that beef carries religious aversion there.

That said, it has proven to be a useful detector of currency misalignment.

The Economist reported that the gap between Argentina’s average annual rate of burger inflation (19 per cent) and official reported inflation (10 per cent) is far bigger than in any other country.

That year the media began reporting on unusual behaviour by the more than 200 Argentinean McDonald’s restaurants.

They no longer prominently advertised Big Macs for sale and the Big Mac was being sold for an unusually low price compared to other items.

The government reportedly forced McDonald’s to sell the Big Mac at an artificially low price to manipulate the country’s performance on the Big Mac index.

The latest Big Mac index published on The Economist website was in July 2015. There are two indices — a raw index that compares Big Mac prices at their nominal values and an adjusted index that takes into consideration gross domestic product per capita of each country given the expectation that the price would be lower in a poorer country.

In July, the rand was trading at approximately 12.50 to the US dollar. The raw index found that the rand was undervalued by 56.3 per cent at that stage and the adjusted index was sitting at an undervaluation of 29.7 per cent.

Given that the currency has depreciated by more than 20 per cent to the greenback since then, it is likely that this undervaluation conclusion will stay the same.

The Kenya shilling does not feature on the Big Mac index given that McDonald’s does not have operations in the country. But there are other common eateries we can use as a reference point.

The Steers burger costs R27.90 in South Africa and Sh350 in Kenya, an index of R1: Sh12.54, meaning Steers sees the rand to be currently undervalued by 47 per cent.

A burger (served with chips) at a Spur restaurant in Cape Town will set you back R65.90 but if you dine in Nairobi, it will cost Sh700.

The Spur burger index is, therefore, Sh10.62 for a single unit of the rand, a 38 per cent undervaluation for the latter currency at its current exchange rate.

Finally, a burger at KFC costs R29.90 and Sh470 in South Africa and Kenya respectively. The KFC index amounts to R1: Sh. 15.71 and the highest undervaluation of the rand at 58 per cent.

Whereas there is a likelihood of inflation in South Africa on the back of a depreciating local currency that will see the prices of burgers rise, such increases are unlikely to counter the undervaluation percentages recorded above which are quite significant.

The rand-shilling exchange rate is, therefore, at its incorrect value and any speculator with spare shillings should consider acquiring rand assets on the cheap before the currency begins to experience a correction.

Mr Chesaina is a chartered accountant based in South Africa and founding editor of The African Professional magazine. Twitter - @africankc