EME Strategy: Türkiye - inflation accounting - demystifying the enigma

Starting from the FY23 reporting season, Turkish companies are transitioning to inflation-adjusted financial reporting for both their consolidated TFRS financials (submitted to the Borsa Istanbul) and their statutory tax financials. IAS 29 Financial Reporting in Hyperinflationary Economies is a complicated concept, affecting the entire set of financials. All non-monetary items carried at historical cost are indexed with relevant CPI coefficients to restate them for the purchasing power as at the reporting date. While IAS 29 tries to sterilise a company’s financials from the distorting effects of hyperinflation, such as inflated gross margins or the understated value of fixed assets, it is not a perfect tool, as it uses a general price index to restate historical figures, and it cannot represent the true economic returns of a company perfectly. For instance, the monetary gain/(loss) item driven by the IAS 29 restatement is mostly of a non-cash nature and accrual based.

In this report, we try to explain the basic principles of inflation accounting, illustrating these with examples of how the nominal TRY financials are restated, highlighting the limitations of inflation-accounting and explaining the necessary changes to our valuation approach to Turkish equities post-IAS 29 migration. In our view, 2024E will be a transitional year for the Turkish market, as the sell-side is still adapting its forecasts and valuation approach to the post-IAS 29 reality, while financial sector companies (with a 19% weight in the BIST100) will only switch to inflation-accounting in 1Q25E. According to the consensus CPI forecasts, the cumulative three-year inflation in Türkiye will not fall below 100%, the key threshold required to terminate IAS 29 application, before mid-2027E at the earliest. This, in our view, makes a broad understanding of inflation accounting a must for anyone exposed to Turkish equities.