149

CHAPTER 7

STUDY OF PRICE ESCALATION CLAUSE IN BUILDING

CONSTRUCTION CONTRACTS IN INDIA

7.1 INTRODUCTION

Generally, in the construction industry, the contractor works in an

environment of risk and uncertainty caused by the economic factors such as

fluctuations in the costs of materials, labour and equipment. Contractors and

suppliers working in today’s volatile materials market find that estimating,

bidding and financing the construction projects are challenges. Many face

significant losses or erosion of anticipated profits because many of them are

locked into fixed price construction contracts where contractors bear the risk

of material price and supplier cost increases. Without the price escalation

clause that allows for an adjustment to the contract price, if there is an

unexpected rise in the market prices of key construction materials, a

contractor will have no respite from such increases. It is necessary to have an

escalation clause in the contract to guard against a sudden spurt in the cost of

materials. To reduce this degree of risk, it is necessary for the contractor to

include large contingencies in initial estimates of the contract when he

tenders the contract. If the contingencies are overestimated, the probability of

the contract being awarded to another contractor is increased. On the other

hand, if the contractor does not allow for inflation and interest rate correctly,

his initial tender would be too low and he would suffer significant losses

(Keller et al., 1982). In high inflationary times, one solution to mitigate the

150

effect of cost escalation is the use of escalation clauses in the contract

(Touran and Lopez 2006). Inflationary trends in economy, boom in

construction activity, seasonal affects and cost of borrowing money have

increased the inherent risk present in construction projects (William 1994,

Keller 1982). This risk could be minimized by inclusion of a escalation

clause in the construction contract (Blair 1993, Panchadhari 1992, Kalra

1983). Escalation clauses are used in the contract to avoid cost overrun by

the contractor and reduce the contingency amount in the contractor’s bid.

7.2 OBJECTIVES

The objectives of the present study are to (i) study the escalation

clauses presently used in construction contracts adopted by various

Government departments/ agencies in India (ii) the adequacy of

compensation paid to the contractor based on currently used escalation

clauses in government contracts and (iii) how far cost escalation has impact

on the outcome of construction projects.

7.3 METHODOLOGY

This investigation was undertaken in two phases. The first phase

included a literature review and interviews conducted among experts with

more than 25 years of experience in construction projects such as Chief

Engineers, Directors (Contracts) and Superintending Engineers. The second

phase included a questionnaire survey. Questionnaires were directed towards

representatives from Government client organizations and contractors. The

questionnaires were distributed to client representatives in the level of

Assistant Engineers to Chief Engineers of CPWD, MES and TNPWD and

contractor representatives who have executed projects for these

organizations.

151

7.4 NEED FOR PROPER ESCALATION CLAUSES IN

GOVERNMENT CONSTRUCTION CONTRACTS

During the past few years there has been a steep increase in the

prices of steel, cement, brick, coarse aggregates, sand and other building

materials. The price of cement, steel and brick for the past five years i.e. from

2003 to 2008 is shown in Figures 7.1, 7.2 and 7.3 respectively.

125160 170

210

255 260

0

50

100

150

200

250

300

2003 2004 2005 2006 2007 2008

Year

Pric

e of

cem

ent p

er b

ag (i

n R

s)

Cementprices

Figure 7.1 Prices of construction materials – Cement Source: Builders Association of India (Southern Centre)

15000

2650029500 30500 32500

55000

0

10000

20000

30000

40000

50000

60000

2003 2004 2005 2006 2007 2008

Year

Pric

e of

ste

el p

er M

T (in

Rs)

Steel prices

Figure 7.2 Prices of construction materials – Steel Source: Builders Association of India (Southern Centre)

152

48006000

7500

10000

12500 13000

0

2000

4000

6000

8000

10000

12000

14000

2003 2004 2005 2006 2007 2008

Year

Pric

e of

brick

s pe

r 300

0 N

os(R

s)

Cost of Bricks

Figure 7.3 Prices of construction materials – Brick

Source: Builders Association of India (Southern Centre)

From Figures 7.1, 7.2 and 7.3, it is seen that price of cement has

gone up by about 112% ; the price of steel products has gone up by about

267%; and prices of bricks has gone up by about 171%. There have been

similar increases in the cost of sand, coarse aggregates and other items used

by the construction industry. The rise in wholesale price index for all

commodities, cement and steel from1996 to 2007 is as shown in Table 7.1.

Table 7.1 Wholesale Price Index in India (Base: 1993-94)

Year/Index 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

All commodities

125.6 131.3 138.9 143.8 152.8 160.7 164.7 173.4 184.9 193.7 203 212.8

Cement 137 129.2 129.3 129.5 129.3 150.5 145.1 146.2 151.1 162.5 190.1 213

Steel 121.9 128.4 132.7 133.9 136.2 136.6 140.8 168.3 222.5 253.5 246.1 269.4

From Table 7.1, it is seen that between 1996 and 2007, the index

of cement has gone up by about 56%; the index of steel products has gone up

by about 121% and, index of all commodities have gone up by about 70%.

153

Considering the continuous fluctuation in material prices and wages of

labour, there is a need to have proper escalation clauses in construction

contract. The basic rationale for a price escalation clause is to compensate the

contractor for increase in construction costs which are beyond the control of

both parties.

7.5 CURRENTLY USED ESCALATION CLAUSES IN

GOVERNMENT CONSTRUCTION CONTRACTS

In India, Government departments, organizations, public sector

undertakings have adopted different formulae to compensate the contractor

on the price variations of materials, labour and Petroleum, Oil and Lubricant

(POL). However, some departments continued with fixed rates of contracts

without allowing any compensation to contractor. Some typical escalation

formulae used in central/ state government construction contracts namely

Central Public Works Department, Military Engineer Services, Tamil Nadu

Public Works Department are given in Table 7.2. Escalation clauses adopted

in Airports Authority of India and Bharat Sanchar Nigam Limited are similar

to CPWD escalation clause, hence these formulas adopted by them are not

shown in the Table 7.2. An overview of the escalation clauses used in

Government contract is shown in Table 7.3, which shows the type of

escalation clause, project duration where the escalation clause is applicable

in the contract, components involved for the escalation, type of index used

for materials and labours in the contract. The details of escalation clauses

used in construction contracts in India is presented in Appendix 2.

154

Table 7.2 Escalation formulae used in construction contracts adopted by various government departments/ agencies in

India

Item Compensated

Central Public Works Department Military Engineer Services Tamil Nadu

Public Works Department

Cement c 0C

0

X CI CIV W100 CI

--Nil-- CC

PV 0.85 R100

1 0

0

C CC

Steel S 0

S0

X SI SIV W100 SI

--Nil--

Ss

PV 0.85 R100

1 0

0

S SS

Materials

0M

0

MI MIXmV W100 MI

0

0

CI CIV P QCI

1 0M M2 M1

0

W WE V VW

MM G S B

KV V V V100

mM

PV 0.85 R100

1 0

0

M MM

Plant and Machinery spares --Nil - --Nil --

ps

PV 0.85 R

100

1 0

0

P PP

POL 0F

0

FI FIZV W100 FI

PE = PG1

K V100

1 0

0

F FF

fP

PV 0.85 R100

1 0

0

F FF

Labour 0L

0

LI LIYV W100 LI

LE = LG1

K V100

1 0

0

L LL

lL

PV 0.85 R100

1 0

0

L LL

Bitumen --Nil - --Nil - bP

PV 0.85 R100

1 0

0

B BB

155

Client organisations have now incorporated escalation clause in

the contract conditions. But the question is the efficacy of escalation clause

and how well they compensate the contractor The basic formula approach

remains the same everywhere with only percentage of profit, material, labour

and POL component being the varying part. The study is focusing on base

period, index associated with the clause, time period and extension of time

and other relevant conditions.

Table 7.3 Overview of the escalation clauses presently used in construction

contracts adopted by various government departments /

agencies in India

Description Central Public Works

Department

Military Engineer Services

Tamil Nadu

Public Works Department

Airports Authority of India

Bharat Sanchar Nigam

Limited

Compensation shall be payable for works whose stipulated period of completion is

6 months or less

0 to 18 months

> 18 months

> 6 months > 12 months > 6 months

> 12

months

Clause in the general conditions of contract

10C 10CA 10CC Special

conditions Special

conditions 10CC 10C

Components involved for escalation Material

and Labour

Material

Cement

Steel

Materials

POL

Labour

Material

POL

Labour

Cement, Steel,

Material, POL

Labour, Bitumen, Plant and Machinery

Spares

Material

POL

Labour

Cement

Steel

Material

POL

Labour

Index used for materials

-- WPI WPI WPI WPI WPI WPI

Index used for Labour

-- CPI CPI CPI CPI CPI CPI

156

From the above, it is clear that in all government construction

contracts, the escalation in material prices is measured by using wholesale

price index and escalation in labour prices are measured by using the

consumer price index.

7.5.1 Escalation Clauses in Central Public Works Department

In India, Central Public Works Department (CPWD) deals with

public works of central government works in the country. CPWD is more

than 150 years old and contract forms of the CPWD form the basis of many

other contract forms followed by other Central and State Government

Departments. For the first time in March 1963, a sub-clause 10C was

introduced in CPWD contract forms (Gupta, 1992). In the current CPWD

Contract agreement, there are three escalation clauses namely Clause 10C,

Clause 10CA and Clause 10CC (General conditions of contract for CPWD

works (2008)). These are summarized below.

7.5.1.1 Project completion time 6 months or less

Clause 10C, under this clause increases as a direct result of coming

into force of any fresh law, statutory rule or order (but not due to change in

sales tax/ VAT) in the prices of any materials and wages of labour beyond 10

percent of the price prevailing at the time of receipt of the tender for the work

are reimbursable. Whereas materials issued by the department at a fixed

recovery rate are not affected. Base time for purpose of this clause is the date

of receipt of tender and the clause is applicable during the stipulated period

of contract or duly extended period of work. Any increase/ decrease is not to

be considered if the same occurred due to delay on the part of contractor.

Engineer-in-charge’s decision in this regard is final and binding. The

contractor is required to keep books of records and other documents as are

157

necessary to show the amount of any increased claim and also required to

intimate the department of such increase in a reasonable time.

7.5.1.2 Project completion time between 0 to 18 months

Clause 10 CA, under this clause contractor is compensated for

increases/decreases beyond the price(s) prevailing at the time of the last

stipulated date for receipt of tenders (including extensions, if any) for the

work, then the amount of the contract shall accordingly be varied and

provided further that any such variations shall be effected for stipulated

period of contract including justified period extended under the provisions of

Clause 5 of the contract without any action under Clause 2. However, for the

work done/ during the justified period extended as above, it will be limited to

indices prevailing at the time of stipulated date of completion or as prevailing

for the period under consideration, whichever is less. The increase/ decrease

in prices shall be determined by the All India Wholesale Price Indices for

Materials as published by Economic Advisor to Government of India,

Ministry of Commerce and Industry and base price for materials as issued

under the authority of Director General (Works), CPWD as valid on the last

stipulated date of receipt of tender, including extension if any and for the

period under consideration. In case, price index of a particular material is not

issued by Ministry of Commerce and Industry, then the price index of nearest

similar material as indicated in schedule ‘F’ shall be followed

7.5.1.3 Projects completion time more than 18 months

Clause 10CC, under this clause, the contractor is compensated for

increases in the prices of cement, materials, Labour, POL as per formula

given in Table 7.2. The method prescribed for working out such increases for

the work done during the stipulated period or duly extended period of the

158

contract. Escalation is payable on 85 percent of the work done as per the bill,

running or final after deducting the value of materials supplied at fixed prices

by the department and some other items which are payable at the market rate

prevailing at the time when the work is executed. The increases for materials

and Labours are worked out on the basis of indices issued by Ministry of

Commerce and Industry and Ministry of Labour respectively. The month in

which the tenders were stipulated to be received is considered as the base

month. The escalation is worked out quarterly including the month in which

the tender was accepted and thereafter at 3 months interval. The relevant

index for any quarter for which escalation is payable is the arithemetic

average of the indices relevant to 3 previous calendar months. The value of

materials supplied by the department at fixed rates and hire charges of plant

and machinery issued by the department are deducted. Full value of material

for which secured advance is paid is included in the cost worked out as

above and later on adjusted when materials are consumed. The components

of cement, steel, materials, labour and P.O.L etc are pre-determined for every

work and incorporated in the conditions of contract attached to the tender

papers and decision of Engineer-in-charge in working out such percentage

shall be binding on the contractor.

7.5.2 Escalation Clauses in Military Engineer Services (MES)

The price variation clause is applicable only for works whose

completion period stipulated in the tender is more than six months,

irrespective of the cost of the project. Period of working out the variation in

escalation payment is three months. Complete set of drawings are issued by

the client before the work starts and hence contractor can estimate and plan

the project properly. The contractor is not eligible for escalation payment

beyond original project duration even if the delay is due to the owner. No

adjustment, whatsoever, due to variation in prices of materials and fuel and

159

rate of wages of labour on account of coming into force of any fresh law or

statutory rule or order as provided for in the conditions of contract is made.

No adjustment in price system is made for materials brought at site after the

due date of completion or after extension of time granted under the contract

(whichever is later) for the works done under the contract. For labour

component though the escalation is paid on the Minimum Wages still the rise

will be payable on the basis of wages increase of unskilled male mazdoor and

not of other categories. The clause is highly unjustified. Entire amount is

eligible for escalation and profit component is not excluded from the price

adjustment clause. The last adjustment for variation in wages of labour is

done for period ending on the date of completion or extended' date of

completion. No adjustment is however made for work done after due date of

completion or extension of time granted under conditions of contract. The

first price adjustment in respect of variation in wages of labour is worked out

for the relevant quarter during which the variation takes place

For implementing this provision, the period of reckoning in such

quarters is split into two periods i.e. the first period upto which RAR is

payable immediately after the date of variation and the second period upto

the end of the quarter. Value of L1 at the beginning of the second period is

the altered rate of wages. If there are more than one change in wages in a

quarter then there will be more than one or two periods of reckoning on

similar basis. Amount payable to work done for any quarter is worked out

after the minimum wage of unskilled adult male mazdoor as fixed under any

law statutory rule or order for the relevant quarter are available. For purpose

of calculation of retention money. LD, the recovery of water charges, income

tax, the value of contract as revised by the above price is binding Wholesale

Price Index applicable for any date shall be the one applicable for the

corresponding week ending Saturday. The weekly index numbers of

160

Wholesale Price Index for all commodities published by the Economic

Advisor to the Government of India is generally formed provisional. Final

index numbers for the corresponding weeks are published subsequently. It is

to be ensured that the variations arc worked out based on the Final index

numbers only.

The Comparison study of Escalation Formula with various

countries is presented in Table 7.4.

Table 7.4 Comparison of Escalation Formula With Various Countries

Formula India Brazil Malaysia UK Selection Basis CPWD By Client General basic Standard Adjustment Trigger

Time Time Cost % variation Time

Coefficients Proportional to contract work set by Engineer.

Fixed Set by contractor Set by Engineer

Material Selection

All commodities whole sale index used.

By FGV By Engineer By Engineer

Ruling Base Date

Time of Tender Set by Contractor

30 days before the tender due date.

42 days before the tender due date.

Certificate Index Date

Quarter prior to Certificate

Month of Certificate

Date of proved cost

42 days before certificate.

Fixed Component

15% none Variable 30-50% set by Engineer

Variable 10-20% set by Government.

Scope Labour, Materials, POL

Taxes, Labour, Materials, Fuel and Plant

Labour Materials and Plant

Labour, Material and Plant

Source : Mechanisms for Adjusting Price Variations. Papers on price Variation Clause :

NICMAR Publication.

161

7.6 SURVEY RESULTS AND DISCUSSIONS

To study the adequacy and the extent of price escalation

compensation to the contractor based on the currently used escalation clause

in government contracts and also need to improve the currently used

escalation in Government Construction contracts in India a questionnaire

survey was undertaken. Out of 215 questionnaires sent/delivered directly to

the concerned, 119 responses were received were after personal requests and

visits to their respective offices. The response rate of 56 percent is considered

to be very good for this kind of a mail survey. During such visits, along with

questionnaire responses, discussions/unstructured interviews were also

carried out with the above respondents.

Questions regarding how the cost escalation has an impact on the

quality of the project produced, project completion time, source of dispute

between clients and contractors and need to improve the currently used

escalation clauses in government construction contracts were asked from the

respondents to indicate their responses based on overall project experience.

The summary of responses received from the respondent is presented in

Table 7.5.

162

Table 7.5 Summary of responses regarding how the cost escalation has

impact on the construction projects

Impact of cost

escalation on

Disagree Agree

Stro

ngly

Mod

erat

ely

Slig

htly

Neu

tral

Slig

htly

Mod

erat

ely

Stro

ngly

(1) (2) (3) (4) (5) (6) (7) (8) (9)

Quality of the project produced

Client 66 no.

No. of resp 2 1 -- 4 14 24 21 %ge 3.0% 1.5% -- 6.1% 21.2% 36.4% 31.8%

Contractor 53 no.

No of resp 12 18 6 1 9 5 2 %ge 22.6% 34.0% 11.3% 1.9% 16.9% 9.4% 3.8%

Project Completion time

Client 66 no.

No. of resp 1 -- 1 -- 4 16 44 %ge 1.5% -- 1.5% -- 6.1% 24.2% 66.7%

Contractor 53 no.

No of resp 0 1 0 0 2 20 30 %ge -- 1.8% -- -- 3.8% 37.7% 56.6%

Source of dispute

Client 66 no.

No. of resp -- 1 1 -- 7 24 33 %ge -- 1.5% 1.5% -- 10.6% 36.4% 50.0%

Contractor 53 no.

No of resp 0 0 0 1 0 10 42 %ge -- -- -- 1.9% -- 18.9% 79.3%

There is a need to improve the currently used escalation in Government construction contracts

Client 66 no.

No. of resp -- -- -- -- 5 12 49 %ge -- -- -- -- 7.6% 18.2% 74.2%

Contractor 53 no.

No of resp 0 0 0 0 0 8 45 %ge

-- -- -- -- -- 15.1 84.9%

From Table 7.5 the survey results show that about 90% of the

client representatives are of the opinion that cost escalation affects the quality

of the project produced and about 69% of the contractors representatives they

disagree that the cost escalation affects the quality of the project produced.

About 97% of the clients and 98% of contractors representatives they agree

that the cost escalation affects the delay in completion of the projects. About

163

98% of the contractor’s representatives and 94% of clients representatives are

of the opinion that the cost escalation is a source of dispute. All the clients

representatives and contractors representatives are of the opinion that there is

need to improve the currently used escalation clause in Government

construction contracts.

Questions regarding the what extent to which the compensation as

per the currently used escalation clause in Government contracts reflect the

actual price escalation for the components of cement, steel, materials, labour,

petroleum, oil and lubricant were asked from the respondents to indicate

their responses based on overall project experience. The summary of

responses received from the respondent is presented in Table 7.6.

From Table 7.6, compensation to the contractors based on the

currently used escalation clause in government contracts, the survey result

shows that about 98% of contractors representatives and 85% of the clients

representatives are of the opinion that they are compensated less than 60% of

the actual escalation of the cement prices. Similarly, about 95% of the

contractor representatives and 88% of the clients representatives are of the

opinion that they are compensated less than 60% of the actual escalation of

the steel prices. On compensation towards price escalation on materials, 96%

of the contractors representatives and 94% of the clients representatives are

of the opinion that they are compensated less than 60% of the actual

escalation of the material prices.

164

Table 7.6 Summary of responses in regard to what extent does the

compensation as per currently used escalation clause reflect the

actual escalation

Respondent Type < 50%

50-60%

60-70%

70-80%

80-90%

90-100%

>100%

(1) (2) (3) (4) (5) (6) (7) (8) (9)

Cement

Client 66 no.

No. of resp 49 8 6 -- 3 -- -- %ge 74.2% 12.1% 9.1% -- 4.5% -- --

Contractor 53 no.

No of resp 41 11 1 -- -- -- -- %ge 77.4% 20.8% 1.9% -- -- -- --

Steel

Client 66 no.

No. of resp 43 15 6 -- 2 -- -- %ge 65.2% 22.7% 9.0% -- 3.0% -- --

Contractor 53 no.

No of resp 35 15 2 1 -- -- -- %ge 66.0% 28.3% 3.8% 1.9% -- -- --

Materials

Client 66 no.

No. of resp 50 12 2 2 %ge 75.8% 18.2% 3.0% 3.0%

Contractor 53 no.

No of resp 41 10 1 1 %ge 77.4% 18.9% 1.9% 1.9%

Labour

Client 66 no.

No. of resp 42 17 5 2 %ge 63.6% 25.8% 7.6% 3.0%

Contractor 53 no.

No of resp 30 17 4 2 %ge 56.6% 32.1% 7.5% 3.8%

POL

Client 66 no.

No. of resp 43 16 6 1 %ge 65.1% 24.2% 9.1% 1.5%

Contractor 53 no.

No of resp 38 12 2 1 %ge 71.7% 22.6% 3.8% 1.9%

With regard to compensation towards price escalation on POL,

about 90% of client’s representatives and 94% of the contractor’s

representatives are of the opinion that they are compensated less than 60% of

the actual escalation of POL. Similarly, on compensation towards price

escalation on Labour, 90% of the clients and contractor representatives are of

the opinion that they are compensated less than 60% of actual escalation of

labour wages.

165

A question as to whether WPI is suitable for calculating

compensation for escalation of the construction projects and BCI is

appropriate index for calculating escalation payment was asked. The

respondent indicated their responses based on overall project experience. The

summary of the responses received from the respondent is shown in Table

7.7.

Table 7.7 Summary of responses in regard to whether WPI is suitable for

calculating compensation for escalation

Disagree Agree St

rong

ly

Mod

erat

ely

Slig

htly

Neu

tral

Slig

htly

Mod

erat

ely

Stro

ngly

(1) (2) (3) (4) (5) (6) (7) (8) (9)

WPI is not suitable for calculating compensation for escalation of the building projects

Client

66 no.

No. of resp 1 1 1 6 17 40

%ge 1.5% 1.5% 1.5% 9.1% 25.8% 60.6%

Contractor

53 no.

No of resp 1 - 19 33

%ge 1.9% - 35.8% 62.3%

Building Cost Indices are more appropriate index for calculating escalation payment for the building projects

Client

66 no.

No. of resp 5 10 51

%ge 7.6% 15.2% 77.3%

Contractor

53 no.

No of resp 1 11 41

%ge 1.9% 20.8% 77.4%

From table 7.7, the survey result shows that about 96% of the

client’s representatives and 98% of the contractor’s representatives are of the

opinion that WPI is not suitable for calculating escalation. Similarly, it is

166

clear that all contractor and clients representatives are of the opinion specific

building cost indices are a more appropriate index for calculating escalation

payment for the building construction projects.

Questions regarding satisfaction level of currently used escalation

clause in Government contracts was asked. The respondents indicated their

responses based on overall project experience. The summary of responses

received from the respondents is presented in Table 7.8.

Table 7.8 Summary of responses received from the respondent on

satisfaction level of escalation clause in contract

Respondent

Type Very High

High Average Low Very Low

(1) (2) (3) (4) (5) (6) (7) Satisfaction level of escalation clause in contract

Client 66 no.

-- 3 14 29 20

-- 4.5% 21.2% 43.9% 30.3%

Contractor 53 no.

-- -- 6 17 30

-- -- 11.3% 32.1% 56.6%

From Table 7.8, the survey result shows that about 89% of

contractor’s representatives and 75% of the client’s representatives are of the

opinion that their satisfaction level with the currently used escalation clause

in government construction contract is low. About 22% of client’s

representatives and 12% of the contractor’s representatives are of the opinion

that their satisfaction level is average. Only about 5 % of the clients

representatives are of the opinion that satisfaction level of currently used

escalation clause used in contract is high.

167

In the questionnaire, questions regarding the appropriate project

duration for consideration of escalation clause in the contract based on

overall project experience were asked. The summary of the responses

received from the respondents are presented in Table 7.9.

Table 7.9 Project duration for which the escalation clause should be

included

Respondent

Type > 3

months >6

months >12

months >18

months

All projects irrespective

of time

(1) (2) (3) (4) (5) (6) (7)

Appropriate project duration for inclusion of escalation clause in contract

Client

66 no.

13 40 9 1 3

19.7% 60.6% 13.6% 1.5% 4.5%

Contractor

53 no.

20 26 - - 7

37.7% 49.1% - - 13.2%

From Table 7.9, the results show that about 61% of clients

representatives and 50% of contractor representatives are of the opinion that

if the duration of the project is more than 6 months then, the escalation

clause can be considered.

Study of Wholesale Price Index In India: The compensation

under escalation clauses of CPWD, MES, TNPWD and all other government

contracts in India are based on the variation in wholesale price index. The

Office of the Economic Adviser, Department of Industrial Policy and

Promotion, Ministry of Commerce and Industry compiles and disseminates

weekly Wholesale Price Index (WPI) numbers on an all-India basis. The

broad break up of materials covered and weights under WPI index is shown

in

Table 7.10.

168

Table 7.10 Details of weights of various groups in WPI (Base 1993-94)

No. of items (Base 1993-94)

Weights (Base 1993-94

series) Group 1 Primary articles 98 22.025

Group 2 Fuel, Power, Light and Lubricant

19 14.22624

Group 3 Manufactured product 318 63.75

All commodities 435 100.00

From the above, it is seen that around 435 commodities are

involved in the groups which includes food items and many materials like

fertilizers, tobacco, papers, textile etc which are not actually related to the

construction activity. Further going into details on a selective basis, around

12% of listed commodities are likely to affect building industry directly or

indirectly and the balance have no impact. From this it is evident that the

compensation paid under escalation clause is not reflecting truly because it

covers 435 commodities which do not affect building construction industry.

WPI Vs. CPWD Cost Index: The Central Public Works

Department (CPWD) has been publishing the building cost indices since

1958. To study the relevance of wholesale price index into building

construction industry. The cost indices of WPI and CPWD from 1994 to

2005 were analysed and the same is shown in Figures 7.4 and 7.5.

169

0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

Inde

x va

lue

Year

WPI CPWD Cost Index

Figure 7.4 WPI Vs. CPWD Cost index (1994-2007)

0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

400.00

Inde

x V

alue

Month

Steel - Trend in WPI Vs. Actual Price Index

WPI

Actual Price Index

Figure 7.5 Steel – WPI vs Actual Market Price Index (1994-2007)

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7.7 FINDINGS IDENTIFIED AND RECOMMENDATION

The price variation clauses in government construction contracts in

India - details of the findings and recommendation are given below:

a) For Material Component: It is found that compensation paid to the

contractor based on the present escalation clause in government

contracts is not adequate to compensate for escalation in

Materials, Labour and POL. This is because the wholesale price

index is used in the formula for calculating the payment for

escalation. It is recommended that the indices of building cost

index should be used for calculating the escalation payment

instead of wholesale price index. Price escalation in material

components like steel, cement and brick etc. should be

reimbursed on actual procurement prices.

b) In government construction contract, major material components

like steel, cement are supplied by the clients. While, calculating

the escalation payment for components of material, labour and

POL, the material supplied by the client is deducted from the

overall cost of work. In reality when the cost of material supplied

by the client is deducted, the cost of handling such material also

gets deducted. Whereas in the calculation of escalation the cost of

handling materials supplied by the client should be added. In

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short the escalation clause should consider the labor and POL cost

of handling such material supplied by the client.

c) For Labour Component: In government contract, while calculating

labour escalation payment, minimum daily wage in rupees for an

unskilled adult male mazdoor is used. In reality the construction

industry today employs predominantly large skilled labor force.

Therefore while considering the escalation for labor component it

would be appropriate to consider the average daily wage for both

skilled and unskilled adult male mazdoor.

d) In government contracts there is no uniformity in terms of time of

contract for applying the escalation clause and it varies with the

organization. A single uniform standard period is not in vogue.

Escalation clause should be uniformly included in every contracts

where the project duration is more than six months.

e) Escalation during extended period of contract: The clause in most

of the government contract states that escalation is not provided

for extended period of contract. In Government contract, even if

the delay is due to the client, escalation payment is not provided

to the contractor. Escalation may be provided to the contractor for

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extended period of the contract, if the delay is from the client. If the

delay is due to the contractor’s actions, necessary penalty shall be

recovered from the contractor. One-sided conditions of contract

should be avoided.

f) Most of the government contracts have a one sided clause,

protecting only the interest of the clients. One-sided clauses in

contracts should be avoided. The current government contracts

forms have conditions that have not undergone any major change

in the last 150 years. These will have undergo major changes to

reflect the current day scenario. Government contract forms

should be reviewed and modified on the lines of world bank,

projects which are quite fair and equitable

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7.8 CASE STUDY OF SIX BUILDING CONSTRUCTION

PROJECTS IN INDIA

A brief overview of the building construction projects studied,

overall impact of “Escalation of materials, labour and POL components” in

each project and comparison of their impact with results of the survey

analysis is given in Table 7.12.

Table 7.11 Adequacy of compensation paid to the contractor based on

the presently used escalation clause in government contracts

in Indian Building Construction Projects

Adequacy of compen-sation paid

to the contractor

Building construction projects

Project name

Construction of

International Terminal Building

Construction of

Information Centre

Building

Construction of School

Building

Construction of

Residential Building

Construction of Hostel Building

Construction of

Residential Building

Type of contract

Item–rate Item-rate Item-rate Item-rate Lump sum Item-rate

Form of contract

CPWD MES MES CPWD CPWD MES

Impact of adequacy of compensation paid based on presently used escalation clause

Cement component

less than 60% Less than

45% Less than

45% Less than

60% Less than

60% Less than

50%

Steel Component

Less than 60%

Less than 40%

Less than 50%

Less than 50%

Less than 55%

Less than 45%

Other Materials

Less than 50%

Less than 50%

Less than 50%

Not considered

Less than 50%

Less than 50%

Labour component

Less than 50%

Less than 50%

Less than 60%

Not considered

Less than 60%

Less than 50%

POL component

Less than 50%

Less than 50%

Less than 60%

Not considered

Less than 50 Less than 60%

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7.9 SUMMARY

In India, CPWD is more than 150 years old and contract forms of

the CPWD form the basis of many other contract forms followed by other

Central and State Government Departments. CPWD has been used as a role

model for formulating the contract. Price variation clauses 10C, 10CA and

10CC have many drawbacks/ flaws. Some of the drawbacks in these clauses

are: for materials, Wholesale Price Index is not truly representating the actual

price rise in construction industry. Lack of Construction Cost Indices forces

the client to use Wholesale Price index for escalation payment. The labour is

compensated using Consumer Price Index which many times are less

compared to Minimum Wages. Escalation is not provided for extended

period even if the delay is due to the client. The material component is

deducted from all the components viz material, labour and POL which is not

fair. Rise in prices of materials like cement, steel, bitumen, explosive etc

should be reimbursed on actual basis on the basis of quantities used every

month as they form the major part of construction. This is now done in many

contracts.

A survey of client and contractor representatives was conducted to

study the adequacy of compensation paid to the contractor based on the

currently used escalation clause in government contracts and cost escalation

impact on the building projects in India. The survey showed that both groups

generally agree on the compensation paid to the contractor based on the

currently used escalation clause in government contract is not adequate for

the components of Materials, Labour and POL. The most important cause for

gap between actual escalation occurred and escalation payment made based

on currently used escalation clause in government contract is mainly due to

applying wholesale price index in the escalation formula for calculating

escalation payment. While most client representatives agree that cost

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escalation has impact on the quality of the project, the contractor

representatives donot agree with this. The survey showed that both client and

contractor representatives agree that escalation clause should be included in

the contracts where the project duration is more than 6 months. The survey

revealed that most client and contractor representatives are not satisfied with

the currently used escalation clause in contract and feel the need to improve

the currently used escalation clause in government contracts. The

respondents opined that cost escalation could impact the project schedule

and cause delays in project completion. The dissatisfaction with the

escalation provisions could cause dispute between clients and contractors.