Read the original text at espreso.tv.
According to the Big Mac index, Ukrainian hryvnia has once again topped the list of the most undervalued world currencies against the dollar. To be precise, hryvnia is undervalued by 68.8% against the dollar and by 62.6% against the euro. The Big Mac Index suggests that the dollar in Ukraine is to be worth UAH 7.74 instead of the current rate of 24.8 hryvnia/dollar. As for the euro, its real value is 10.21 hryvnia at the current rate 27.3 UAH / EUR.
Russia, South Africa, and Malaysia are among the countries with the most undervalued local currency (over 50%). Russian ruble is undervalued by 59.3% against the dollar and 51.3% against the euro.
What is The Big Mac index
The Big Mac index was invented by The Economist in 1986 as a lighthearted 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 this case, a burger) in any two countries. For example, the average price of a Big Mac in America in July 2016 was $5.04; in China it was only $2.79 at market exchange rates. Therefore, the "raw" Big Mac index says that the yuan was undervalued by 45% at that time. The Big Mac index has become a global standard, included in several economic textbooks and the subject of at least 20 academic studies.
Can we trust The Big Mac index?
At first glance, the Big Mac Index is quite unserious and even humorous. However, there are certain trends which it points at.
Economists underline that often the Big Mac Index suggests long-term trend in the exchange rate. For example, undervalued currencies expect growth; otherwise, the central banks of those countries have to deal with strengthening by selling the currency.
However, the Big Mac Index ignores many factors. For example, the level of salaries, which in poor countries is lower than in rich ones, and therefore it fundamentally affects the cost of products.
In addition, the final price of a burger depends on the cost of the products, fees, rent, and other pricing factors, and these nuances are not reflected in the Big Mac Index.
It is believed that Big Mac in Ukraine is four times cheaper than in the US, partly due to the low purchasing power of the Ukrainians. Simply put, it is difficult to compare the average income of the average American and the average Ukrainian. Moreover, the index does not show the situation in the economy in general, but only in the consumer market.
For this reason, the Big Mac Index is suitable for comparison only in the case of currencies of countries with similar levels of development.
Cheap hryvnia - is it bad?
At first glance, it seems that underestimating the currency makes no economic sense for the population. Growth of the dollar often pulls inflation.
However, the cheap local currency provides many advantages. This country becomes an attractive location for production due to inexpensive labor and low production cost.
Typically, the national currencies are understated in the export-oriented economies, as Ukraine is presumed to be. It is particularly beneficial to export anything from the country and sell it for dollars precisely because of cheap money.
Ukraine has proposed to replace the Big Mac Index with the so-called "Borscht Index," as borscht is more relevant meal for the country. This index makes it possible to compare the price of this soup in Ukraine and abroad.
It is also a good attempt to show a stable market price for Ukrainian products, and even to show that food prices dropped.
The main ingredients of borscht are beetroot, potatoes, carrots, cabbage, tomatoes, greens, and meat. The index takes average prices in different cities around the world and counts the cost in local currency.
However, Borscht Index is still more difficult to use than the Big Mac Index. Not all countries have the necessary ingredients. In addition, there is some confusion in the units. Most talk about the pot of borscht, but they are of different sizes too. Sometimes the index is measured in liters and bowls.