This article is educational content explaining how a category of financial instrument generally works. It is not investment advice and does not describe any specific current event, company, or security.
A bond that promises a fixed 4% annual coupon can, over a decade of high inflation, pay out investors far less real purchasing power than a bond structured to yield only 2%. The difference lies not in the coupon rate printed on the certificate, but in whether the bond’s payments are tied to a monthly government statistics release: Israel’s Consumer Price Index (CPI). Understanding how that linkage is built into the bond’s mechanics, rather than left to chance, is central to grasping one of the more distinctive features of Israel’s fixed income market.
How CPI Indexation Is Built Into the Bond
Israel’s Ministry of Finance and many corporate issuers sell two broad categories of shekel-denominated bonds: CPI-linked bonds, commonly known by the government series name “Galil,” and unlinked, fixed-rate bonds, known as “Shahar.” In a CPI-linked bond, both the principal (the amount repaid at maturity) and each periodic coupon payment are adjusted upward, or downward, in line with the change in Israel’s CPI between the bond’s issue date and each payment date. Mechanically, the issuer calculates an indexation ratio, comparing the CPI level at the relevant payment date to the CPI level at issuance, and multiplies both the coupon rate and the outstanding principal by that ratio before making the payment. This means the coupon rate quoted on a Galil bond, often a modest real rate, is applied not to the original face value, but to a face value that has already been scaled up for cumulative inflation since issuance.
Because the adjustment happens inside the cash flows themselves, holders of CPI-linked bonds do not need to separately hedge against inflation to preserve the purchasing power of their return, at least with respect to the CPI measure used. The indexation is calculated using CPI data published by Israel’s Central Bureau of Statistics, typically with a short reporting lag built into the bond’s terms so that the relevant index figure is known before each payment date.
Shahar Bonds: Fixed Nominal Payments Regardless of Inflation
Shahar bonds work differently: they carry a fixed nominal coupon rate set at issuance, and both coupon and principal repayments remain constant in shekel terms for the life of the bond, irrespective of how the CPI moves afterward. If inflation runs higher than markets expected when the bond was priced, the real, inflation-adjusted, value of a Shahar bond’s fixed payments erodes. If inflation runs lower than expected, the opposite occurs, and the fixed payments end up worth more in real terms than originally priced. This is the standard structure used across most global government bond markets, and it places the entire inflation outcome, whether favorable or unfavorable to the holder, on the investor rather than the issuer.
The two structures also differ in how compensation for expected inflation is embedded in pricing. A Shahar bond’s nominal yield already reflects the market’s collective expectation for future inflation over the bond’s life, plus a real return component. A Galil bond’s yield is quoted directly in real terms, since inflation is handled separately through the indexation mechanism rather than being folded into the headline rate.
Comparing the Two Structures Side by Side
The gap between the yields available on comparable-maturity Galil and Shahar bonds is sometimes referred to as the breakeven inflation rate: roughly, the average annual CPI change over the bond’s remaining life that would leave an investor indifferent between holding either structure. This figure is tracked by market participants and by the Bank of Israel as one gauge of inflation expectations embedded in bond prices, though it also reflects liquidity and risk premium differences between the two markets, not inflation expectations alone.
Both bond types trade on the Tel Aviv Stock Exchange and are issued regularly by the government, alongside similarly structured corporate bonds from Israeli companies. The structural choice between CPI-linked and unlinked debt is a design decision made by each issuer at the time of issuance, reflecting how it wishes to allocate inflation risk between itself and its bondholders, rather than a feature that changes over the life of an individual bond.
