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Global

Hyperinflation accounting: Coming to an emerging market near you

  • 20% of surveyed countries have inflation rates above 20%. In 80% of these cases, inflation is on an upward trajectory

  • Companies in 12 countries should now be applying hyperinflation accounting; this number could rise to 20 by year-end

  • High inflation rates and weakening currencies distort the corporate profitability outlook, clouding the investment case

Hyperinflation accounting: Coming to an emerging market near you
Rahul Shah
Rahul Shah

Head of Financials Equity Research

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Contributors
Rabail Adwani
Rohit Kumar
Tellimer Research
22 July 2022
Published byTellimer Research

Recent high inflation prints in North America and Europe have shocked many observers, leading some commentators to revise upwards their central bank rate hike forecasts. But single digit inflation is already a distant memory in many emerging markets, with the strong US dollar exacerbating existing supply chain and input cost issues.

The countries with the highest inflation rates

Based on the most recent announcements, we estimate that in around 20% of countries, inflation currently exceeds 20%.

The inflation rate exceeds 20% in around 20% of countries

Moreover, in around 80% of countries, inflation is still increasing. Countries with high and increasing inflation include Lebanon, Zimbabwe, Syria, Turkey, Argentina, Sri Lanka and Iran.

Inflation is still rising in 80% of countries

High inflation exacerbates investment risk 

For international investors with exposure to companies in these markets, there are several risks they need to manage:

  • Currency risk. High inflation can be associated with local currency weakness, which reduces the value of the investor’s holdings in their home currency. Firms with currency mismatches may record sizeable gains/losses when currency exchange rates move sharply, an additional source of volatility.

  • Leverage. Where investee companies have hard currency debt, their leverage and debt burden ratios may deteriorate. The higher interest rates associated with elevated inflation will also play a part in lifting borrowing costs.

  • Profitability. Rising input costs may squeeze margins if these cannot be transferred to the end customer. Macro uncertainty may discourage firms from making value-added investments, negatively affecting long-term growth.

Hyperinflation accounting – rationale and impact

As per IAS29 ‘Financial reporting in high inflationary economies’, the intention of applying hyperinflation accounting is to provide more meaningful financial information to consumers of financial statements.

In contrast to the usual historical cost accounting approach adopted when preparing financial statements, firms’ assets and liabilities are recorded at their value on the balance sheet date. Any restatements are based on a general price index, applied to the period between when the item first appears in the accounts and the balance sheet date, with any change in value recorded separately in the profit and loss account. In practice, the restatements are limited to non-monetary assets and liabilities, such as fixed assets and inventory.

Where prior period balance sheets undergo the same adjustment process, the change in value is taken to other comprehensive income rather than through the profit and loss account.

When to apply hyperinflation accounting

This is essentially a judgement call, but the intention is that all companies in an economy should adopt (or dis-adopt) hyperinflation accounting practices in tandem.

Key indicators supporting the adoption of hyperinflation accounting include:

  • A tendency for the general population to keep its wealth in non-monetary assets (eg real estate) or a stable foreign currency

  • A tendency for prices of goods and services to be quoted in a stable foreign currency rather than in local currency

  • Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period

  • Interest rates, wages and goods/ services pricing are linked to a price index

  • The cumulative inflation rate over the prior three years approaches 100%

The countries already adopting hyperinflation accounting, and those that could join the list

As per the international accounting standards board (IASB), 10 countries should have adopted hyperinflation accounting in their 2021 financial statements, as shown in the table below.

So far this year, the IPTF (International Practices Task Force) of the Centre for Audit Quality (CAQ) has indicated that Ethiopia and Turkey should also adopt hyperinflation accounting, with Angola and Haiti on the watchlist. The body notes that other markets could also be included in the watchlist (such as Afghanistan and Ukraine) but they did not monitor them. Looking at the current crop of high inflation countries, we would also highlight Sri Lanka, Ghana, Pakistan and Nigeria as markets where further monitoring is advisable.

Countries meeting hyperinflation accounting criteria

Financial implications

We have reviewed a sample of financial statements prepared under hyperinflation accounting rules. The picture is mixed, with each company’s specific circumstances determining the outcome. In the short term, the relative power of suppliers and customers will determine the extent to which firms can pass on higher input costs. But over the long term, hyperinflationary conditions will likely prove negative; it is difficult for firms to make long-term investment plans in the volatile economic conditions associated with hyperinflation, which ultimately damages their competitive positioning.

QNB recently reported a 10% hit to H1 22 group profits due to the application of hyperinflation accounting to its Turkish subsidiary, Finansbank. The firm believes the future impact of the hyperinflation accounting adjustment will be lower, as inflation moderates and better hedging practices are observed (for example, via CPI-linked loans).

We have reviewed the accounts of selected large listed firms in Argentina. Although there were negative implications in prior years, in 2021 most firms showed a benefit from the application of hyperinflation accounting rules. This highlights that the reporting implications of hyperinflation accounting are not necessarily negative, but will depend on the relative size of net monetary assets and liabilities, and firms' net foreign currency positioning (since depreciating currencies tend to contribute to hyperinflationary conditions).

Lebanese bank accounts showed qualified audit reports in 2021; one reason for this was the absence of hyperinflation accounting.

Zimbabwe’s Econet reports results on both inflation-adjusted and historical cost bases. The inflation-adjusted results were below those calculated on a historical cost basis; key reasons were higher depreciation, amortisation, interest and tax charges, and the monetary adjustment line item.

Econet: comparison of inflation-adjusted and historical cost accounts