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Was the Metical Overvalued?

The dramatic decline of metical/dollar exchange rate (currently at 50MZN / 1USD) raises questions as to whether the Metical was overvalued.

An exchange rate is the rate which one currency can be exchanged for another. There are two types of exchange rate regimes; Floating or completely determined by the Market forces of supply and demand, and fixed exchange rate – that requires substantial central bank interventions. Mozambique applies a hybrid regime, classified as “managed floating” or “floating with a life jacket” —meaning that although market forces play a large role, the central bank often intervenes to restore the exchange rate to a controlled equilibrium.

Purchasing power parity (PPP) is an economic measure of an an accurate exchange rate. It measures a common basket of goods between two countries assuming that if the exchange rate is accurate (PPP=1) then identical assets will sell at the same price in the different countries. Otherwise, people will buy in cheap markets and sell in dear ones until prices equalize.

A simplified measure of the PPP is something known as the Big Mac Index (McDonalds hamburger index). I’ll use this to verify the accuracy of the current exchange rate now (50MZN/1 USD) vs the exchange rate at in January 2015 (35MZN/1USD) using United States prices as a benchmark. I’ll use economic “cost of living data” for both countries, valid as of December 2015. In this case, because Mozambique does do not have McDonalds franchise, we’ll use the price of an equivalent meal.

Mozambique price 350 MZN vs USA price 7USD

At the current exchange rate of 50MZN/1USD the price is almost equal to the cost of the same meal in America.  HOWEVER, at an exchange rate of 35 MZN / 1USD the price is (2.10 USD or 105 MZN) CHEAPER.

Let’s compare another item; (Milk 1 liter):

Mozambique price 61.25 MZN vs USA price 0.95¢

At the current exchange rate of 50MZN/1USD, (Milk 1 liter) in Mozambique is (13.75MZN or .27¢) more than in America.  At, an exchange rate of 35 MZN/1USD the price becomes (27.75 MZN or .55¢) CHEAPER than in America.

At an exchange rate of 50MZN to 1USD, purchasing power parity is almost (1) equivalent in both counties. While at an exchange rate of 35MZN/ 1USD PPP is substantially less.

Therefore, it appears that at 35MZN to 1USD the Metical was overvalued.

Its important note that the cost of living is 46% less expensive in Mozambique than in America and that the wage (therefore productivity gap) remains very large between these two countries. However, this analysis shows that the welfare gap as measured by the PPP is narrower.

The reasons for currency manipulation are clear, as a country with a trade deficit and net importer running of most consumer goods needs a stronger currency.  A weaker currency makes imports more expensive exerting inflationary pressure on prices and depleting purchasing power of citizens.

Data Source:

  1. Cost of living in the United States & Mozambique[http://www.numbeo.com/cost-of-living/country_result.jsp?country=United+States] Accessed on 14, December 2015.
  1. The Big Mac Index [https://en.wikipedia.org/wiki/Big_Mac_Index] Accessed on 16, December 2015.