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.

300
Price of cement per bag (in Rs)

255 260
250
210
200 170
160 Ce m ent
150 125 price s

100

50

0
2003 2004 2005 2006 2007 2008

Year

Figure 7.1 Prices of construction materials – Cement

Source: Builders Association of India (Southern Centre)

60000 55000
Priceof steel per MT(inRs)

50000

40000
32500
29500 30500
30000 26500 Steel prices

20000 15000

10000

0
2003 2004 2005 2006 2007 2008
Year

Figure 7.2 Prices of construction materials – Steel

Source: Builders Association of India (Southern Centre)
 152

14000 13000
12500

Price of bricks per 3000 Nos(Rs)

12000
10000
10000

8000 7500

6000 Cost of Bricks

6000 4800

4000

2000

0
2003 2004 2005 2006 2007 2008
Year

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
125.6 131.3 138.9 143.8 152.8 160.7 164.7 173.4 184.9 193.7 203 212.8
commodities
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.
Table 7.2 Escalation formulae used in construction contracts adopted by various government departments/ agencies in
India

Item Central Public Works Tamil Nadu

Military Engineer Services
Compensated Department Public Works Department
 X   CI  CI 0   P   C  C0 
Cement VC  W   c     --Nil-- VC  0.85   C   R   1 
 100   CI 0   100   C0 
 X   SI  SI0 
Steel VS  W   S     --Nil--  P  S S 
 100   SI0  Vs  0.85   S   R   1 0 
 100   S0 
 Xm   MI  MI0   W  W0 
VM  W     E M   VM 2  VM1    1 
 100   MI 0   W0  P   M  M0 
Materials  CI  CI0  K  VM  0.85   m   R   1 
V  PQ  VM   M  VG    VS  VB   100   M0 
 CI0   100 

 Pp   P1  P0 
Plant and Machinery Vs  0.85    R   
--Nil - --Nil --
spares  100   P0 

 Z   FI  FI0  K   F F   P  F F 
POL VF  W     E P =  P  VG1    1 0  VP  0.85   f   R   1 0 
 100   FI 0   100   F0   100   F0 
 Y   LI  LI0  K   L1  L 0   P   L  L0 
Labour VL  W     E L =  L  VG1     VL  0.85   l   R   1 
 100   LI 0   100   L0   100   L0 
 P   B  B0 
Bitumen --Nil - --Nil - VP  0.85   b   R   1 
 100   B0 

154
 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

Bharat
Military Tamil Nadu Airports
Central Public Works Sanchar
Description Engineer Public Works Authority
Department Nigam
Services Department of India
Limited
Compensation
shall be
payable for 6
0 to 18 > 18 > 6 months > 12
works whose months > 6 months > 12 months
months months months
stipulated or less
period of
completion is
Clause in the
general Special Special
10C 10CA 10CC 10CC 10C
conditions of conditions conditions
contract
Components Cement Cement, Steel, Cement
involved for Material, POL
Material Steel Material Material Steel
escalation
and Material Materials POL Labour, POL Material
Labour Bitumen, Plant
POL Labour Labour POL
and Machinery
Labour Spares Labour

Index used for

-- WPI WPI WPI WPI WPI WPI
materials
Index used for
-- CPI CPI CPI CPI CPI CPI
Labour
 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
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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 Time Time Cost % variation Time
Trigger
Coefficients Proportional to Fixed Set by contractor Set by Engineer
contract work
set by Engineer.
Material All By FGV By Engineer By Engineer
Selection commodities
whole sale
index used.
Ruling Base Time of Tender Set by 30 days before 42 days before
Date Contractor the tender due the tender due
date. date.
Certificate Quarter prior to Month of Date of proved 42 days before
Index Date Certificate Certificate cost certificate.
Fixed 15% none Variable 30-50% Variable
Component set by Engineer 10-20% set by
Government.
Scope Labour, Taxes, Labour, Labour Materials Labour,
Materials, POL Materials, Fuel and Plant Material and
and Plant 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.
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Table 7.5 Summary of responses regarding how the cost escalation has
impact on the construction projects

Disagree Agree
Impact of

Moderately

Moderately
Strongly

Strongly
cost

Slightly

Slightly
Neutral
escalation
on

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

Client No. of resp 2 1 -- 4 14 24 21
Quality of 66 no. %ge 3.0% 1.5% -- 6.1% 21.2% 36.4% 31.8%
the project
produced Contractor No of resp 12 18 6 1 9 5 2
53 no. %ge 22.6% 34.0% 11.3% 1.9% 16.9% 9.4% 3.8%
Client No. of resp 1 -- 1 -- 4 16 44
Project 66 no. %ge 1.5% -- 1.5% -- 6.1% 24.2% 66.7%
Completion
time Contractor No of resp 0 1 0 0 2 20 30
53 no. %ge -- 1.8% -- -- 3.8% 37.7% 56.6%
Client No. of resp -- 1 1 -- 7 24 33
Source of 66 no. %ge -- 1.5% 1.5% -- 10.6% 36.4% 50.0%
dispute Contractor No of resp 0 0 0 1 0 10 42
53 no. %ge -- -- -- 1.9% -- 18.9% 79.3%
There is a Client No. of resp -- -- -- -- 5 12 49
need to 66 no. %ge -- -- -- -- 7.6% 18.2% 74.2%
improve the
No of resp 0 0 0 0 0 8 45
currently
used %ge
escalation in Contractor
Government 53 no. -- -- -- -- -- 15.1 84.9%
construction
contracts

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

< 50- 60- 70- 80- 90- >100

Respondent Type
50% 60% 70% 80% 90% 100% %
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Client No. of resp 49 8 6 -- 3 -- --
66 no. %ge 74.2% 12.1% 9.1% -- 4.5% -- --
Cement
Contractor No of resp 41 11 1 -- -- -- --
53 no. %ge 77.4% 20.8% 1.9% -- -- -- --
Client No. of resp 43 15 6 -- 2 -- --
66 no. %ge 65.2% 22.7% 9.0% -- 3.0% -- --
Steel
Contractor No of resp 35 15 2 1 -- -- --
53 no. %ge 66.0% 28.3% 3.8% 1.9% -- -- --
Client No. of resp 50 12 2 2
66 no. %ge 75.8% 18.2% 3.0% 3.0%
Materials
Contractor No of resp 41 10 1 1
53 no. %ge 77.4% 18.9% 1.9% 1.9%
Client No. of resp 42 17 5 2
66 no. %ge 63.6% 25.8% 7.6% 3.0%
Labour
Contractor No of resp 30 17 4 2
53 no. %ge 56.6% 32.1% 7.5% 3.8%
Client No. of resp 43 16 6 1
66 no. %ge 65.1% 24.2% 9.1% 1.5%
POL
Contractor No of resp 38 12 2 1
53 no. %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

Moderately

Moderately
Strongly

Strongly
Slightly

Slightly
Neutral
(1) (2) (3) (4) (5) (6) (7) (8) (9)
WPI is not Client No. of resp 1 1 1 6 17 40
suitable for 66 no. %ge 1.5% 1.5% 1.5% 9.1% 25.8% 60.6%
calculating
No of resp 1 - 19 33
compensation
Contractor 1.9% - 35.8% 62.3%
for escalation of
the building 53 no. %ge
projects
Building Cost Client No. of resp 5 10 51
Indices are more 66 no. %ge 7.6% 15.2% 77.3%
appropriate
No of resp 1 11 41
index for
calculating
Contractor
escalation
payment for the 53 no. %ge 1.9% 20.8% 77.4%
building
projects

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 Very Very

High Average Low
Type High Low
(1) (2) (3) (4) (5) (6) (7)
Satisfaction level Client -- 3 14 29 20
of escalation 66 no. -- 4.5% 21.2% 43.9% 30.3%
clause in
Contractor -- -- 6 17 30
contract
53 no. -- -- 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

All projects
Respondent > 3 >6 >12 >18
irrespective
Type months months months months
of time
(1) (2) (3) (4) (5) (6) (7)
Appropriate project Client 13 40 9 1 3
duration for inclusion 66 no. 19.7% 60.6% 13.6% 1.5% 4.5%
of escalation clause
Contractor 20 26 - - 7
in contract
53 no. 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.
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Table 7.10 Details of weights of various groups in WPI (Base 1993-94)

Weights
No. of items
(Base 1993-94
(Base 1993-94)
series)
Group 1 Primary articles 98 22.025
Group 2 Fuel, Power, Light and 19 14.22624
Lubricant
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

350.00
WPI CPWD Cost Index
300.00

250.00

Index value 200.00

150.00

100.00

50.00

0.00

Year

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

Steel - Trend in WPI Vs. Actual Price Index

400.00

350.00

300.00

250.00
Index Value

WPI
200.00
Actual Price Index

150.00

100.00

50.00

0.00

Month

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 Building construction projects
to the
contractor
Construction Construction
Construction Construction
of of Constructio Construction
Project of of
International Information n of School of Hostel
name Residential Residential
Terminal Centre Building Building
Building Building
Building Building
Type of
Item–rate Item-rate Item-rate Item-rate Lump sum Item-rate
contract
Form of
CPWD MES MES CPWD CPWD MES
contract
Impact of adequacy of compensation paid based on presently used escalation clause
Cement Less than Less than Less than Less than Less than
less than 60%
component 45% 45% 60% 60% 50%
Steel Less than Less than Less than Less than Less than Less than
Component 60% 40% 50% 50% 55% 45%
Other Less than Less than Less than Not Less than Less than
Materials 50% 50% 50% considered 50% 50%
Labour Less than Less than Less than Not Less than Less than
component 50% 50% 60% considered 60% 50%
POL Less than Less than Less than Not Less than 50 Less than
component 50% 50% 60% considered 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.