Opinion – From Grain to Grain: Big Mac Index points out that Real is valued in relation to emerging markets, but not because of the picanha

Since December 2019, the Real has depreciated by 25% against the dollar, jumping from R$4/USD$ to R$5/USD$. When we evaluate this devaluation in isolation, we tend to believe that it was too much. However, this is not what the Big Mac index indicates.

In the last eighteen months, the Dollar has appreciated more than 15% against the main currencies in the world. This appreciation took the US currency to the highest level in the last two decades. This appreciation of the Dollar can be seen in the chart below.

Contrary to the global movement, the Real appreciated this year, reaching the value of R$4.6/USD$, but soon returning to R$5/USD$. At that time, many said it made sense, as Brazil is a commodity exporter and these are rising.

In fact, according to academic work developed with my partnership (link), commodity prices are related to the exchange rate.

However, the movement was driven by a strong inflow of foreign capital. As soon as this flow was reversed, the exchange rate also returned to the direction of international pairs.

As everyone knows, forecasting the exchange rate is an arduous task. However, we can see how the currency is doing relative to others when we look at the price of a common good standardized and sold in different countries.

This is the case with the Big Mac sandwich. Thus, the Big Mac index was created as a way of estimating how expensive a currency would be in relation to others.

According to a Bloomberg survey, shown in the figure below, the Real is the most valued currency among the currencies of emerging countries. Therefore, for a foreign consumer who comes with a dollar, eating a Big Mac in Brazil pays more than in any other emerging country.

The table above shows that all currencies would be cheap against the Dollar, that is, they are more devalued. The Real would be the most expensive among them, that is, it would have less room for appreciation against emerging peers. Therefore, the movement we have now is something more structural and not exclusive due to internal effects.

The table above shows the ranking of the main currencies, according to the Big Mac index.

See that the Real would be more expensive than the Euro. In other words, today it is cheaper to eat a Big Mac in Europe than in Brazil.

The appreciation of the Dollar against the main currencies is justified by the expectation of an increase in interest rates in the US. So, to hold the exchange rate, our interest rate may have to rise even more if the US raises interest rates higher than expected.

Michael Viriato is an investment advisor and founding partner of Investor’s House

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