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Big Mac Index Highlights Czech Crown’s Undervaluation

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Since the start of this year, the Czech crown has maintained elevated positions against major global currencies. However, this doesn’t align with the pricing of the renowned Big Mac burger, revealing its ongoing undervaluation.

The Czech crown is estimated to be undervalued by 13% when measured against the dollar, as per the Big Mac Value Index. While the popular beef sandwich costs $5.58 in the United States by the close of July, it demands 105 crowns in the Czech Republic.

These findings imply that the appropriate exchange rate should be 18.82 crowns per dollar. However, the actual rate as of the end of July was weaker, standing at 21.65 crowns per dollar.

The undervaluation story extends further when considering the euro. In comparison with countries where the euro is the mode of payment, the Czech currency, known as the króna, is undervalued by almost 17%. In the euro zone, the cost of the favored sandwich averages 5.28 euros.

In light of this, given the Czech burger cost of 105 crowns, the exchange rate should ideally be 19.89 crowns per euro. Nevertheless, at the conclusion of the previous month, one euro held a value of 23.87 crowns.

The Big Mac Index, an informal measure, has been calculated biannually since 1986 by The Economist magazine as a lighthearted approach to comparing currency purchasing power across nations. The index rests on comparing Big Mac hamburger prices in diverse countries, serving as a gauge for currency overvaluation or undervaluation against the US dollar.

The core premise is that the ubiquitously available American hamburger, sold under the McDonald’s brand in over 100 countries, should be affected by unique economic aspects in each nation, like raw material costs, wages, and inflation, as outlined by The Economist.

Importantly, when adjusting for inflation, the price of a hamburger increased by 10.5% in the Czech Republic compared to the prior year, and in the United States, this increase amounted to 8.3%.

Challenges of the Index

The creators themselves acknowledge that the globally embraced index isn’t without its flaws. Critics often point out that purchasing power parity remains an economic theory and faces practical hindrances. One argument contends that due to lower labor and operational expenses, a hamburger is naturally more affordable in developing nations.

Hence, in 2011, the British Weekly introduced a modified version of the Big Mac Index, incorporating labor costs across countries. Its computation leans on per capita gross domestic product. In this light, the króna doesn’t seem as undervalued as it does under the basic Big Mac index. Against the dollar, it displayed a 1.8% rise by the end of July. While the difference is less pronounced against the euro, according to this index, the Czech krona’s undervaluation is 15% (in contrast to 17% in the baseline).

Going back a year, the index reflected the domestic currency’s 23% undervaluation against the dollar, when the exchange rate was roughly CZK 24 per dollar. However, this trend shifted in early autumn the prior year, with the króna strengthening by approximately 8% against the US dollar over the past year.

The Czech National Bank’s (ČNB) higher interest rates compared to the US central bank have played a role in this. This factor rendered the króna more attractive to investors seeking superior returns. The perks of a robust króna also encompass more cost-effective imports from the US.

On the flip side, if Czech investors were to acquire US dollar-denominated stocks, the value of their investment might dip due to the robust króna. This means that even if, in theory, the value of dollar-denominated stocks remains unchanged, they might be worth less when converted into króna.

The index formulated by the British weekly additionally illustrates that the Polish zloty is undervalued by 10.7% against the dollar and the Hungarian forint by 28.5%. The zloty’s exchange rate has notably climbed, shifting from a nearly 25% undervaluation against the dollar back in late January.

According to analyst Petr Lajsek from the brokerage firm Purple Trading, this can be attributed to the appeal of the Polish currency, akin to the Czech situation, among speculators due to higher interest rates.

“The Japanese yen remains considerably undervalued, by more than 43%, owing to the ongoing loose currency conditions in the Japanese market. Notably, the Bank of Japan remains the sole central bank worldwide upholding negative interest rates.”

A Potential Weakening of the Czech Krona

Lajsek notes that the euro exchange rate is also intriguing to observe. Last year, for several weeks, it even dropped below parity, signifying a scenario where the dollar was stronger than the euro. Presently, the exchange rate hovers around $1.10 per euro. Therefore, based on the index, the single European currency is overvalued by 4.3%. This marks a substantial shift from January when, conversely, the euro was undervalued against the dollar by 1.5%.

Despite the continued interest rate hikes in the US, Laisek anticipates a slight dollar weakening by year-end.

“In turn, the euro could face even more significant overvaluation. Inflation within the eurozone remains elevated, necessitating even higher interest rates.” On the other hand, the Czech krona, for which the market anticipates the potential for the first interest rate cut, might weaken. This adjustment could potentially occur as early as this year. Moreover, the Czech National Bank has officially ceased interventions to prop up the Czech krona, which could lead to notable weakening in the upcoming months,” asserts the analyst.



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