A dollar should cost R$4.50, the Big Mac index shows; Understand – 01/27/2023

The dollar was trading below R$5.10 on Friday morning (27). This means that the Brazilian currency has been devalued by 11.6% relative to its “correct” value, and it should be worth R$4.50.

This calculation is based on the Big Mac Index, which has been presented by The Economist since 1986, a century-old English newspaper publication that features the world’s most important economies. On Thursday (26), the liberal-progressive economic-line magazine released the update of its famous index of December 2022 values.

Understand the Big Mac indicator

The index is a comic approximation of the relationship between national currencies, based on purchasing power parity (PPP) between economies. The idea is to compare the price of the sandwich in the United States with the price charged in other countries, because the composition of the snack is exactly the same around the world.

Global purchasing power parities, rather than nominal exchange rate comparisons, are used in studies and analyzes of economic issues involving two or more countries. It is understood that exchange rates move and stabilize in the long run according to the evolution of the prices of the same basket of goods and services in each country.

In the December Big Mac index table, the sandwich costs R$22.90 in Brazil and $5.36 in the United States.. The ratio expresses an exchange rate of 4.27, which indicates that the Brazilian currency, which was priced at R$5.16 at the time, will be 17.2% undervalued in relation to its “fair” rate. In this measure, in December, the dollar exchange rate should be 4.27 Brazilian reals. Now in January, the value of the real has depreciated compared to December, resulting in a “fair” exchange rate of R$4.50.

According to the Big Mac Index, at the end of 2022, the Egyptian pound was the currency that depreciated the most against the dollar, in a list of 55 countries. The Swiss franc was the most valuable.. The value of the Egyptian currency decreased by 65.6% from its “correct” value, while the Swiss franc increased by 35.4% from its “fair” value.

The Economist also calculates the “correct” currency quote, from comparing Big Mac prices in each country, based on purchasing power parity over these countries’ per capita income. The Big Mac adjusted for per capita income indicates that the real value in December was 1.1% higher than its real value against the dollar.

The momentary depreciation of the Brazilian currency in relation to the US currency is due to a combination of factors. Expectations to raise inflation Throughout 2023 and the uncertainties related to adjustments in public accounts and containing the upward trajectory of public debt. In this environment the central bank can delay the onset of a cycle of lowering base interest rates by the central bank and, as a consequence, delay impulses of expansion in economic activity. Political factors, such as the instability that occurred at the beginning of the new Lula’s government It also contributes to the devaluation of the riyal against the dollar.