Is The Ringgit Undervalued?

The Malaysian ringgit should be worth 58.9% more against the US dollar, or RM1.72 per dollar, instead of its current level of around RM4.19, according to the latest Big Mac Index released by The Economist (Feb 6, 2022).

Since 1986, the Big Mac Index has been comparing purchasing powers around the world using the price of the world’s most recognisable burger as its benchmark. The index is based on the theory of purchasing-power-parity (PPP), or 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, which the Economist says is never not to be taken as a precise gauge of “currency misalignment”, has now been globally accepted. In its latest edition, the ringgit emerges as the fourth most undervalued of 55 currencies tracked, each measured by GDP per capita and after taking into account differences in the standard of living.

“A Big Mac costs RM9.99 in Malaysia and US$5.81 in the US,” the survey report said.

“The implied exchange rate is 1.72. The difference between this and the actual exchange rate, 4.19, suggests the ringgit is 58.9% undervalued,” it added in reference to the ringgit’s market value earlier this week. What this means is that anyone who earns in ringgit will be able to buy fewer things in the US or any other country because the currency is undervalued.

Source: Focus Malaysia

Among the world’s other most undervalued currencies on the Big Mac index are the Turkish lira, undervalued by 67.9%, the Indonesian rupiah (undervalued by 59.3%) and the Russian ruble (undervalued by 70%).

Meanwhile, the index finds the Swiss franc and the Norwegian krone as the world’s most overvalued currencies.

Due to PPP, the cost to produce a Big Mac is cheaper in poorer countries. To address this, The Economist said it has factored in another important indicator – GDP-adjusted index – to reach a more accurate conclusion. At market exchange rates, a Big Mac costs US$2.39 in Malaysia, 58.9% less than in the US (US$5.81). But based on differences in GDP per person, a Big Mac should cost 37.2% less. This suggests that the ringgit is actually 34.6% undervalued.

On the adjusted index too, Malaysia’s currency remains heavily undervalued at sixth place, but less so than when dealing with straight conversion data. Using this measure, the Russian ruble is the most undervalued currency relative to the US dollar, by as much as 52.1%. Adjusted for GDP per capita, Uruguay has the most overvalued currency at 39.8%.

An index is an index. It is a gauge if perceptions, sentiments and speculation are not accounted for. The ringgit (like some others) is impacted because of interest rate differences, balance of trade/payments, desirability of the currency, policy flip-flops, political instabilities, corruption “tax” and low GDP growth. But together speculators move the exchange rate downward/upward as they deem fit. It is only when reserves of a country are significantly high like China, that speculators withhold any “attack”. Otherwise we could face the fate of Sri Lanka or Pakistan. But capital controls are not a solution if we believe in an open economy and practice the free market regime.

Reference:

Ringgit is fourth most undervalued currency, says latest global purchasing power index, MalaysiaNow, Feb 6, 2022 (https://www.malaysianow.com)