After Turkey’s official inflation rate surged above 70% in May, some global companies, including UK consumer goods giant Unilever, have begun applying hyperinflation accounting to their Turkish operations.
In recent years most European banks with operations in Turkey have been trying to reduce their exposure to Turkey’s cratering economy, with one big exception: Spain’s second largest lender, BBVA. In May, BBVA used some of the money it raised from selling its US operations to increase its stake in Turkey’s second largest private bank, Garanti BBVA, from just under 50% to 86%. Like its larger Spanish rival Santander, BBVA has spent the past couple of decades expanding in high-growth emerging economies as a means of boosting income. But as I’ve warned for a number of years, the strategy is not without its share of risks.
On Tuesday (June 28), one of those risks materialized. BBVA announced it had begun to apply hyperinflation accounting for its Turkish subsidiary Türkiye Garanti Bankası (also known as Garanti BBVA), which was its third largest source of group profits last year. The purpose of hyperinflation accounting, otherwise known as IAS (as in “International Accounting Standard”) 29, is to set specific standards for entities reporting in the currency of a hyper-inflationary economy, so that the financial information provided is meaningful. To that end, companies can opt to restate their financial statements, disclosing their results in real as opposed to nominal terms.
The accounting rules apply retroactively from Jan 1 of the year in question. The impact on BBVA’s first quarter results will be reflected in the bank’s second quarter income statement. In May, the official inflation rate in Turkey was above 70% and BBVA’s base-case scenario is that it will not fall below 60% at any point this year.
This is why BBVA has decided to apply hyperinflation accounting, which will wipe out €324 million from the bank’s P&L statement for the first quarter. Instead of providing €249 million in profits, BBVA Garanti will have generated €75 million in losses. Looking to the rest of the year, BBVA expects Garanti’s earnings in Turkey to be “non-material” to its overall performance, in light of the nation’s expected inflation. Despite taking a huge chunk out of BBVA’s profits, the adoption of IAS 29 does have a silver lining: it increases the bank’s Tier 1 capital ratio by 19bp to 12.89% in Q1 and raises its book value by €254 million.
Inflation Hits 23-Year High
In May, Turkey’s official year-on-year consumer price index (CPI) surged to 73%, a 23-year high. This has happened as the value of the lira against the dollar, which itself is more or less continually losing value, has plunged by almost 25% so far this year, after losing 44% of its value in 2021. The currency is currently trading at 16.68 units to the dollar, compared to 7.44 in January 2021 and 3.78 at the start of 2018.
The more the lira collapses, the higher the rate of inflation surges. In recent years Turkey’s President Recep Erdogan has held almost total sway over the country’s economic and monetary policy institutions, even going so far as to appoint his son-in-law, Berat Albayrak, as Minister of Finance in July 2018, a position he resigned from in 2020. Since 2019 Erdogan has fired three central bank governors for hiking interest rates over-zealously. In January 2022, he fired the director of TUIK for announcing an inflation rate that was deemed too high.
At that time, the official inflation rate was 36.1%. Today, it is over double that (73%) while producer prices have risen to an eye-watering 132%. Yet according to ENAG, an independent group of researchers in Turkey, the real rate of consumer price inflation is actually more than double the official rate, at around 160%. This has put ENAG on collision course with TUIK, which recently sued ENAG, accusing it of seeking to tarnish the national institute’s reputation.
Now, global companies are beginning to consider Turkey’s economy as hyper-inflationary…
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