Big Mac Index Shows Ringgit Undervalued by 61%

This article first appeared in The Edge Financial Daily, on July 25, 2016.

KUALA LUMPUR: Fancy a McDonald’s Big Mac? Good news.

McDonalds’s outlets in Malaysia offer the iconic fast food item at a discount of 60.6% compared to the US.

What does that mean? The ringgit is undervalued by 60.6%, according to The Economist’s Big Mac index.

The “patty purchasing parity” — with a tongue-in-cheek economic reference system devised by the magazine to compare the strength of currencies and even the size of economies — revolves around comparing the price of Big Macs in US dollar terms across countries.

For example, a Big Mac in the US costs US$5.04 (RM20.46) while a Big Mac in Malaysia costs US$1.99 (RM8).

“So Malaysia is offering a very good deal,” The Economist Asia Economics editor Simon Cox told The Edge Financial Daily in a phone interview.

However, according to the magazine, a more sophisticated version of the Big Mac index, which takes into account fundamentals, shows that the dollar is overvalued by a much smaller margin: roughly 11% on a trade-weighted basis.

While highlighting that the undervalued ringgit serves to cushion any impact from slower growth in China and across the globe, he said it has also served to undermine the interests of the Malaysian economy.

“It is a bad thing that economic conditions require a weaker ringgit, but given that Malaysia did need a weaker currency, it was a good thing that the currency was able to fall and was allowed to fall without any disruption,” he said.

“What has been interesting in Malaysia is that the ringgit has fallen a long way and going by the Big Mac index, it is quite competitive, quite cheap, but domestic inflation is still very well contained,” he added.

He said that it is not usual in the case for emerging markets, where a sharp fall in currency could result in skyrocketing inflation.

Cox credited Malaysia’s resilience in the face of a declining currency to Bank Negara Malaysia’s (BNM) policies to ensure that inflation would not rise and stay elevated above its targets for a long time.

He also said he does not foresee the ringgit to weaken further, despite BNM’s recent move to cut the overnight policy rate (OPR) by 25 basis points to 3%.

“Sentiment towards emerging markets has steadied after the alarmism of January and February,” he said.

“The 1MDB (1Malaysia Development Bhd) scandal may make it harder to spirit money out of the country, not harder to get money into it,” he added.

Cox said the Malaysian economy is also “faring surprisingly well”, despite news of the 1MDB scandal hitting international headlines.

He credits this to a well-diversified economy, which has a wide manufacturing base aside from commodities.

“I think one misconception about Malaysia among international observers is the idea that it is very commodity-dependent,” he said.

“But commodity exports are quite a small percentage of Malaysia’s total exports, it has got a much more diversified, stronger manufacturing base than people think.

“It is not as if it has been a great time for manufacturing either, but that does mean that Malaysia has been somewhat more resilient than emerging economies,” he added.

Cox said domestic demand has remained reasonably robust, but noted that indicators about the strength of domestic demand have been mixed, suggesting slowing of momentum in domestic demand.

He said BNM’s move to cut the OPR was meant to address this, as the Malaysian economy is now more dependent on domestic demand rather than exports in a time of slowing global economic growth.

“But broadly speaking, I think the cut was meant to forestall trouble rather than being a reaction to trouble, it is more pre-emptive than a reaction,” he added.

The Big Mac index shows that out of 43 countries, only three countries — Switzerland, Norway and Sweden — have currencies that are overvalued when compared to the US dollar, highlighting that the US dollar has climbed 56% above fair value on a trade weighted basis.