Currency risk – The Milk Index

The famous Big Mac index is an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries. However, in terms of Africa, the Big Mac index is less applicable, as Big Mac’s are not readily available across all the markets. An alternative take is the Milk Index, which looks at the relative cost of milk, a product consumed across the continent.

Like the Big Mac Index, the Milk Index infers price levels across the markets, seeking to identify under and overvalued currencies against the US dollar.

Most overvalued currencies based on Milk Index Download the graph PDF (26KB)

Average price for a litre of milk over a year assumed for Milk Index

Country and Currency Code	Actual Price of Milk				Price Index exchange rate vs Average exchange rate
	2015	2016	2017	2019	Calculated	Average LCU/USD	Diff (%)
Angola (AOA)	290.82	352.57	442.36	440.02	536.61	335.67	60%
Ghana (GHS)	7.28	9.02	6.50	11.19	13.65	5.30	157%
Kenya (KES)	86.50	98.58	103.93	107.75	131.40	101.50	29%
Mozambique (MZN)	70.00	102.53	71.74	86.8	105.85	63.81	66%
Nigeria (NGN)	347.98	714.29	613.92	813.33	991.87	307.50	223%
South Africa (ZAR)	13.43	13.78	14.81	15.41	18.79	14.40	31%
Zambia (ZMW)	18.25	14.22	12.44	13.2	16.10	12.85	25%
USD	0.92	1.08	0.86	0.82

^{Source: Numbeo, RMB Global Markets (data as at May 2019), FitchConnect (data as at July 2019), RisCura Analysis}

Average price for a litre of milk over a year assumed for Milk Index Download the graph PDF (26KB)

The findings from this index suggest that many African countries’ currencies are overvalued. Currently, the two most overvalued currencies are the Nigerian naira and the Ghanaian cedi.

The findings from this index suggest that many African countries’ currencies are overvalued. Currently, the two most overvalued currencies are the Nigerian naira and the Ghanaian cedi. This may be connected to depressed commodity prices as most African economies depend on commodity exports as a source of foreign exchange. As a result, central banks such as the Nigerian and Ghanaian central banks tap into their reserves to protect their currencies and guard against imported inflation.

Although central banks have shown readiness to continue to support stable exchange rates by supplying US dollars to the market, the Bank of Ghana has recently discontinued this policy to reduce the losses of reserves, which has resulted in higher depreciation of the Ghanaian cedi in the first quarter of 2019. However, there is a limit to which the central banks can protect the currency from falling. As witnessed in 2016, when the price of crude oil dramatically dropped in the international market, the central banks of oil-exporting countries had no choice but to let their currencies devalue. This is because they didn’t have large enough reserves due to reduced earnings from crude oil sales to support their currencies.

In East Africa, the Kenya shilling is currently overvalued by 29%. Though the government denied the overvaluation, there is no immediate currency crisis as the reserve is sufficient to support the currency. There might be a gradual correction of the overvaluation in the coming period.

The Southern African Currencies (SA rand and Zambian kwacha) are free-floating currencies and should, therefore, autocorrect to fair market value. However, both are currently overvalued. While the kwacha is close to fair value, the rand is overvalued by approximately 31%. This overvaluation may be attributable to the volatility in the currency given that it serves as a proxy for Emerging Market currencies and is therefore highly-traded. Other African currencies are relatively illiquid, except for Nigerian naira and the Egyptian pound.

Differences in the relative availability of the local milk, as well as supply and demand across African countries, may hinder the usefulness of the Milk Index. That could explain why large importers of milk have overvalued currencies compared to others. Furthermore, the index does not adjust for some distorting factors such as tariffs which may differ depending on each country’s fiscal policy.