Inflation-linked bonds: how the principal is indexed

In OFZ-IN it is not the coupon that is indexed but the face value: it is recalculated using the consumer price index published by Rosstat, with a lag of roughly a quarter. The coupon rate is fixed and deliberately low compared with conventional OFZ, but it accrues on the already indexed principal, so the rouble amount of the coupon rises along with prices, and at redemption the investor receives the increased principal, and never less than the original amount. The protection here is strictly defined: it is protection against inflation as measured by one specific index. Against a rise in real rates, the price of such a bond is not protected at all.

What exactly is recalculated

The mechanism is arithmetic performed on one number, the principal. For each issue the issuer maintains an indexation coefficient tied to the CPI:

1. The value of the consumer price index is taken for the month that lies roughly a quarter back from the current date.
2. From it the principal is calculated for every calendar day: the figure changes daily, not once per coupon period.
3. The coupon for the period accrues at the fixed rate on the principal in force on the payment date.
4. At redemption the indexed principal is paid out; if indexation over the whole life of the bond has turned out negative, the payment does not fall below the original principal.

The lag is not a flaw in the design but a consequence of the fact that statistics are published after the event: the index for a month becomes known only once that month has ended. The practical conclusion is simple: the bond reflects past inflation, not the inflation that is unfolding right now. When the inflation trend turns, the linker catches up with reality late, in both directions.

It is important not to confuse this with amortisation: with amortisation the principal is gradually paid out and shrinks, whereas with indexation it is revalued upwards and paid in full at the end.

How this shows up in the price and in accrued interest

A linker's quote is the clean price as a percentage of the current, already indexed principal. The rouble amount of the trade is obtained by multiplying that percentage by the indexed principal and adding accrued interest, which is also calculated on the indexed principal. Hence a frequent surprise for newcomers: the price in percentage terms looks modest, yet noticeably more is debited from the account. The difference is explained entirely by the indexation coefficient, not by "hidden charges". How the clean price turns into the dirty price is covered separately, in the article on bond prices and in the introductory guide to bonds.

Real yield and breakeven inflation

A linker's yield is quoted as a real yield, that is, a yield over and above inflation. The yield on a conventional OFZ is nominal. The difference between them, for bonds of comparable duration, is the implied (breakeven) inflation: the average rate of price growth at which the outcome on the linker and on the classic OFZ will be the same. That is the substance of the choice. By buying OFZ-IN instead of a conventional issue you are not "protecting yourself against inflation" in the abstract; you are taking a position that actual inflation to maturity will turn out higher than breakeven. If it turns out lower, the nominal issue would have been the better deal.

That is why comparing a linker with a deposit or with a corporate issue by one coupon figure is meaningless: these are quantities of a different nature. It is useful to begin by understanding how a bond's yield is calculated in general, and what total bond return is.

Where the protection ends

There are three sources of divergence between expectations and the result.

The real rate. Indexation protects the principal, but not the market price. If the real yield required by the market rises, the price of the linker falls, and the longer the bond, the harder it falls. OFZ-IN issues are long-dated by design, so their sensitivity is high: the mechanics are described in the article on duration.

The choice of index. The protection is tied to the CPI as the official basket. A particular person's own basket, with its share of rent, imports and medical care, may rise faster than the index. In that case the nominal protection is there, but subjective purchasing power is not preserved.

The horizon. The whole structure works as promised only by maturity. Over a short horizon the result is determined by mark-to-market revaluation, not by indexation.

Tax takes part of the indexation

The increase in principal is income, and it enjoys no relief on account of its inflationary nature. Both the coupon and the revaluation result form 13%, which means that the real yield after tax is lower than the one shown in the yield quote. For a long-dated linker this is a material adjustment, not a rounding difference. Exactly which regimes and deductions soften the effect is covered in the article on the tax on coupons; a comparison with the foreign-currency alternative is in the article on substitute bonds.

How to read the parameters of a specific issue

We do not give the numbers for outstanding issues here (the current indexation coefficient, the calculated principal, accrued interest, the real yield), and we cannot: they change daily. For up-to-date values see the OFZ section, and for the terms see the glossary. On the issue's page, check the indexed principal specifically, not the face amount: calculating yield from the face amount gives the wrong answer, and this is the most common mistake made when working with linkers.